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L161—I141 





DOMESTIC AND FOREIGN EXCHANGE 


THE MACMILLAN COMPANY 


NEW YORK - BOSTON - CHICAGO - DALLAS 
ATLANTA + SAN FRANCISCO 


MACMILLAN & CO., Liw1TED 


LONDON » BOMBAY + CALCUTTA 
MELBOURNE 


THE MACMILLAN CO. OF CANADA, Lt. 
TORONTO 


Boviestic AND POREIGN 
EXCHANGE 


POR CAND PRAGTICE 


BY 
LRA CBeeC ROSS. PH:D. 


PROFESSOR OF ECONOMICS, UNIVERSITY OF CALIFORNIA 


Nem York 
THE MACMILLAN COMPANY 


1923 


All rights reserved 


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TO THE MEMORY OF A WONDERFUL 
FRIEND AND COLLEAGUE 
CARLETON HUBBELL PARKER 


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Digitized by the Internet Archive 
in 2021 with funding from 
University of Illinois Urbana-Champaign 


https://archive.org/details/domesticforeigne0Ocros 


PREFACE 


In writing this volume I have sought to prepare a book on the 
exchanges which would be simple and adequate in its treatment of 
the subject, and suited to the needs alike of college students and the 
younger men engaged in actual exchange operations. In my class 
room work [ have used practically all the volumes thus far published 
and have felt the need of a book that would be neither a banker’s 
manual nor a brief and inadequate treatment of the more complicated 
phases of exchange operations. I appreciate the difficulties of others 
who, as beginners, delve into the intricacies of the field, and have 
tried to keep their interests continually in mind, even to the extent 
of being guilty at times of obvious repetition. It is also partly, but 
not solely, because of them that I preface the discussion of foreign 
exchange with a survey of the practices and forms commonly found 
in the domestic field. 

There has been much needless mystery about the workings of the 
exchanges, especially of foreign exchange, due undoubtedly to the 
stress laid by early writers on the theoretical aspects of the subject. 
In the chapters that follow, I have interwoven the more important 
parts of the theoretical with the practical so as to present as complete 
a treatment as is possible within the limits of one volume. I have 
frequently questioned the validity of certain commonly accepted 
theories as tested out in practice, and have urged the advisability of 
avoiding the customary rigid and dogmatic application thereof to 
the field of the exchanges. Much still remains to be done not only 
in this connection but also in the realm of general economic theory. 
It is my sincere hope that the economists of the future will completely 
shake off the influence of the past and formulate a group of theories 
that will be more fully in accord with Twentieth Century conditions. 


vii 


vill PREFACE 


Some progress is already being made in this direction by our younger 
writers. 

Throughout the volume I have not only dealt with the exchanges 
as they are supposed to function normally, but have continually 
referred to those abnormal developments occurring both in times of 
peace and war which call for a closer and more searching examination 
of exchange practices and rate fluctuations and necessitate the adop- 
tion of unusual methods to meet unusual circumstances. 

Many of the details of the practical side of exchange transactions 
cannot be dealt with in writing, but must be learned solely “on the 
job” behind the exchange counter. I have, however, given con- 
siderable space to the more important features of the technique of 
exchange operations so as to place before the student the fundamentals 
of, and the reasons for, some of the more customary practices of the 
business. 

In preparing this work, I have incurred many obligations. I am 
deeply indebted to those banks and exchange dealers which have so 
graciously allowed me to reprint their exchange forms and documents, 
viz., The Guaranty Trust Company, the Irving National Bank, the 
American Express Company, all of New York City; the Anglo and 
London Paris National Bank, the First National Bank, the Inter- 
national Banking Corporation, the Crocker National Bank, and the 
American National Bank, all of San Francisco; and the Merchants 
National Bank of Los Angeles. The Guaranty Trust Company has 
also permitted me to reprint some of the forms appearing in its pam- 
phlet, ‘‘How Business with Foreign Countries is Financed,” and also a 
photograph of its trader’s room, while the Irving National Bank has 
granted me a similar courtesy in connection with certain forms re- 
lating to export credits appearing in its monograph “Trading with 
the Far East.” I am especially eager to make acknowledgment of 
the aid given me by those good friends and co-workers who have read 
all or parts of the manuscript and who have made numerous helpful 
suggestions, viz., Mr. Harry Coe, Vice President of the Anglo and 


PREFACE 1x 


London Paris National Bank and Manager of its Foreign Depart- 
ment; Mr. C. S. Reuter, Assistant Manager of the Foreign Exchange 
Department of the Merchants National Bank of Los Angeles; Dr. 
H. H. Preston of the Department of Economics of the University 
of Washington; Dr. F. Fluegel and Mr. W. R. Robinson of the De- 
partment of Economics of the University of California; Dr. M. W. 
Dobrzensky of the School of Jurisprudence of the University of 
California, and Mrs. E. D. Wilkie of the University of California 
Press. Mr. J. G. Schaffer, Teaching Fellow in the Department of 
Economics of the University of California, has assisted me in check- 
ing many of the exchange calculations appearing in the volume. My 
greatest debt of gratitude is to Mr. Max Rosenberg, a dear good friend, 
without whose sincere interest and encouragement this volume would 
not have been written. 
TRA B. Cross. 

Berkeley, California, 


January, 1923. 





CONTENTS 


CHAPTER PAGE 
PME UERLUCLOS VN ce eher, cn e eltT be hae ene etal Se FED wi I 
Piel Oaler NR ClAClONS A. (0... aia wens ith a nya matte seen ie» | 6 
cla) LOUNGES PGs tala 90 Toa aA Salerno Se cy Oe a 22 
ive Lodorsement, Acceptance, and Liability, «..2...-2.)...00.5.. 79 
RACHA UUCRIOUICIS) ie Stel a: cs UM ei ae Fr hoce. tle otboel kos 04 
PMamierocipies Ou. Forcign Exchange... .. (bee qs Mey vies aes eos 116 
VII. Fundamentals of Foreign Bills of Exchange.................. 137 
MileeLunes OL roreion Bills of Exchange: 2.25... ..5 22. 0400s. es 171 
em CEE Oe OLE CO ECCILS «yeaa lining Maly. Harecg, ec ahh 0G a aren ee wtes 234 
See AL ESCH RAG OAR rs, fy ale dea hte aids Gun wlan vie es Fie os 300 
GMC eC ATICETC TOM VEO VENIECIILS 7.2Gts ume. sion a4 ais cue ads. ca oka ee Les 370 
XII. Exchange Relations with Silver Standard, Gold Exchange, and 
EA Treb at ATCA e a CQUIIREICS wii CLAN diing ctiie se havea dale 427 
Pele lulnvestiment, SpeCUlAHON, ATDILTAPE. kha ei te ee nb eee 487 
pepve Due World War and the:Exchanges. 0.0 6. i.05... eee ee ees ey, 
APPENDICES: 
I. A Typical Correspondent Relations Agreement.............. 555 
rey ADIOS OL, F OLE TCDS 25,0 so 6 at iise) meee «we a wd ees, 557 
RM ee rOU Gite SOUV ECMO Ue Gas wats. s/ at tm synth urd Node wus o eietete Ate ey 559 
OEE eco ee Let <a gs oe bid Fine g a ot 'oro Soh cole .e We wd 567 





FORMS 


FIGURE _ PAGE 
f) Application for domestic money order. ...:.5.6 8.66266 c0805.... 23 
eeeDomestic, postotiice-money order 20). 5 2 Fe oe eee. cP 2d 
memomestic express money Orders to2. eee ie es fee 27 
4. Application for domestic telegraphic transfer................... 28 
PeNOUCe Tomayee O1 telegraphic translers, ai. vr de. eh ke wee 29 
Opapplication for banktelegraphic transfer? > 0.00. 23k. 30 
mebank:s receipt for: telegraphic: transfer 5.000. ster. ak Se: 31 
METS RTA RACHIOCK Steet 5 edt ars OAH Is choc, SAME de TIA ee IEE see 38 
g. Availability schedule for Seattle branch Federal Reserve Bank of 

ate TATCISCO ses semes enter nfs G's Oy: PRR). RE NCU, 6 Ry Oe 42 

choy UREN ES Voie OF yd eae en tc 2 2 Oi ee an ce 46 

MMBUIORSO! travelers CHECKS (i. ) J ice aires ce peeks a 50 


merront page: domestic.circular letterof credits. 2.3090 s%. 50. 82 
moecond page-comestic circular letter of credit e052). ia... 2. 253 
MerTeT OL NCICALOL cei mie heen eee MMe ay kd dks 54 
EE tEeO PCOLLESDONU EHS eh ah eetn tion tries oats ik, Setek ates end 55 
MELTS save Ol Panis SISTAAMre SNCCb sr. 4 uc i cc's vad oh ods ben 56 
mecond page. of bank's signature sheet. 0.20) ae 0 eee ee eps 57 
EIS LAl we et eee ee eRe yk Shi Ne 60 
MEIGEL Vea yi SIC IU Cia Gemeente Creel. 0) els 28s Rea Mat 5 61 
PRIA LULA CET re) renner Namen ey (ere Ue Ns a Sao 61 
MUTANECACCEDLALCG We mnt eer oat Pande rh dete care Gas foele ate all Re as 68 
mevormestic COMmmercial letter-or Credits wer fae lees tere 71 
. Certificate of elegibility of banker’s acceptance................. 76 
MPRTOSSCCICNEC OT meetin ee me areal oie Ra ON ese Plate a's 87 
BPR EOLCSU Did linen wer na main tas away rete cate equal QI 
MPIC IY OLCSL taate fais een wretch PTS Ch imei paste ks wa ahon§ Q2 
. List of offerings of bankers’ acceptances by discount house...... IOI 
. Diagram showing theory of foreign payments.................. 124 
. Diagram showing theory of foreign payments.................. 124 
. Diagram showing theory of foreign payments.................. 125 
. Typical list of foreign money prices...... RE Th yok a aa Racy We 120 
. Instructions accompanying a foreign bill of exchange............ I4I 
. Instructions accompanying a foreign bill of exchange............ 142 
. Instructions accompanying several bills of exchange............. 143 
Meccneraetrerronoypotuecationa ¢ aon... ake fae weedy ak eens 153 
Morac a wip yaexDOr ter, ON/IMpOrtets VA 7 ee Si a 156 
MOST CAIUS NINO OL ACIN Oey wham may es em rts Seer rete Nee yar 159 
MEPSNTANCE I COMINCALO to's Pee tay. EER EE Amite Mantas Sa bee eek 164 
TOSS = cool) EV ec cea Sono Meare a Nei ary Ce ae caries Ca RPP 166 


Xiv FORMS 


FIGURE PAGE 
40; Consular Invoice oii e.evs 0's, ese da e-ul bees AR ae ee epee 167 
41. American Express Company limited check..................... 175 
42. Foreign exchange rate list of American Express Company....... 176 
43. American Express Company postal remittance................. 17 
44. Postal remittance issued by bank through American Express Com- 
PAN. 262 fork od Phe Ch cok rere eee ee hayes Ouse) ie aaa 178 
45.Postal remittance issued by bank). .;c5;- 5: aeece eee ee 180 
46. Advice to foreign correspondent in connection with bank post 
money. Orders). 6:5 cite stad 4.le bovistuetwide sop ae 180 
47. Advice to jobbing bank in connection with bank post money order 181 
48. Original and duplicate bank drafts on foreign account........... 183 
49. Application for bank draft on foreign account.................. 184 
so. Advice of issuing bank to foreign bank. ...... 21.77, . eee 185 
51. Advice to correspondent of foreign correspondent............... 186 
52. Advice to issuing bank by foreign correspondent................ 187 
53. Exchange rate sheets... 2... 25 See wie oe eas bee oe 189 
54. Type of four-part form of bank/draft, ).... vc4 4 190 
55. Lype of four-part form of bank draft. NRA gals ee 
56. Advice to correspondent of foreign correspondent . 1. ie eee 193 
57.. Lype of five-part form of bank draft?) ..- 4a5, + eee 194 
58. Receipt forletter of delegation: ..2.°). -t:htcus 195 
59. Application for cable transter. ......5.24 ee ae tee 197 
Go, Old form of foreign traveler's cheek... 0292s ee 219 
61. New form of foreign traveler's’ check, ...... 749s cee 220 
62. American Express Company’s franc traveler’s check............ 221 
63. Foreign circular letter of créditagreement. -) > 7.) 2 225 
64. First page foreign circular letter:of credit.:....... Soe eee 226 
65. Second-page foreign circular letter of. credit. .).. 042 een 227 
66. Advice-of letter of creditc%,7 oe. ee ih oo ey 228 
67.. Application for commercial letter of credit... ..:.: 2-3 aeeee 237 
68. Agreement signed by applicant for commercial letter of credit.... 238 
69. Dollar import letter of credits). . 2.25. 02, 3 ee 240 
70. Trust receipt (documents for warehousing)................+++-. 245 
71. Trust receipt (goods to be held or sold by importer)............ 246 
72,. Trust. receipt (for delivery. to purchaser) .:..% 1..." sn ees 247 
43. Bailee receipts. 5. 40's aden, alias einai ein ye ae i ca 248 
74.. Sterling import letter of credit : 44,20). sey ae oes ee 256 
4s: Draft with interest, clause i. Jk 2 ae Ge ay = oe 267 
#6. Draft: with colonial clauses ws fg. 25 <  aiceem oeeeae e 271 
a9. Confirmed export, Creditiy, fa: oy sits taty avai eee cee eee 281 
#8. Unconfirmed export credit. = ..259))) 3a santa ee 282 
79. Authority to purchase (letter of guarantee)..................-- 204 
80. Authority to draw or advice of authority to purchase........... 205 


8x. Weekly statement of foreign accounts... .....5..-s555+05+-seme 522 


CHARTS 


CHART PAGE 
I. Highest and lowest quotations for sight sterling per month, 1907, 
Ty Rak Cee Bs Hah Gin aan eae ee AA cae OR ae 320 
MIMEDILeHOLGUETNNO TALES, LOOT a sii. ut aetna) ale ent eess ern ode 362 
Bimmer OMMsterilic’ TALCS. FOLS (07 leniey. sarin Maras eek eked Aes 363 
’ IV. Relation between cable spread and deposit allowance rate in 
PTET eee RS ron 500 als he eaters MRE NEP pe Slay Sead ial levee 304 


V. Maximum and minimum spread of sixty day D/A commercial 
bills and bankers’ bills at varying rates of discount in London, 

MON: Sepa) eA ae ee et SS nr 365 

VI. Gold movements and wholesale prices, United States, 1890-1921. 422 
VII. Price of silver in the United States and wholesale price index, 


DVOUCTIBOD ka GLA PTI 129 vets See ie hl hose ela nb deh 437 

VIII. London quotations of telegraphic transfers, Shanghai, Hongkong, 
and Calcutta, and of price for spot silver, I914-1921......... 443 

IX. High rate for sight drafts on Argentina, Brazil and Chile in New 
Me Diy “ad Fa Sp CoC) AERIS ape Reged aN ane ae CES ae SR 471 

X. Wholesale commodity prices in the United States, England, 
PSAP RNICUS ET HEIN ee cee PrN Sty eo. 5 traits Gee dete SIN i pare atapache 477 

XI. Commodity price indices and New York exchange rates on Eng- 
PC Mia iCe ea YRaAnceserMany siocdisy: S45. ele bs ale tied 483 

XII. Purchasing power parity of sterling, francs, lire and marks, 1917- 
Gee ters Pe een Ls te hin Shy kate thal dWinlia4 ticie ered ate 484 

XIII. Exchange rates in New York on belligerent countries, June, 1914- 
LV n LOLS eee enn nee Oe CU), RE te cialG apn a, wits ohare sis 540 

XIV. Exchange rates in New York on neutral countries, June, 1914— 
CEE eR es eat ey HERS ete the Wir ah cleat yin, yin. 3 Se 541 


XV. Exchange rates in New York on England, France, Germany, 
Italy, Netherlands, Argentina, and Japan, November, 1918- 


PVC LCr an (es Maen ihc eet ore Ee ey Suge ely a chy hoi 544 
ILLUSTRATIONS 

Gold shipment from China being received at San Francisco.......... 385 

erm PCE ten S TOOT ie no. tain bale jiorelevpinie ca Sak Pe Sine basin. & 524 


XV 








_ DOMESTIC AND FOREIGN EXCHANGE 


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DOMESTIC AND FOREIGN EXCHANGE 


CHAPTER I 
INTRODUCTORY 


To the layman and to the student enrolled in university classes in 
finance, the field of Domestic and Foreign Exchange appears at first 
sight to be but a mass of incomprehensible details, complicated and 
therefore meaningless documents, mystical and magical practices 
concerned with creating funds out of “the wind ” and shifting such 
funds, figuratively speaking, almost by wave of hand from one place 
to another for the purpose of making a profit thereon, and last, but 
by no means least, endless columns of figures and tables of mathe- 
matical computations which further serve to heighten the foreboding 
character of the subject. 

Up to within very recent years there has been good reason for the 
extent of ignorance and the lack of interest which has existed among 
us Americans regarding exchange matters, especially as to that part 
of the subject which deals with the principles and practices of foreign 
exchange. Prior to the World War we were not vitally concerned 
with foreign trade; our national task appeared rather to be the caring 
for our domestic requirements. ‘Trafficking with other nations was 
carried on only by fits and spells and as the occasion or the situation 
required. A very small number of American banks had exchange 
departments, and in the few which did, the work of such departments 
was practically a closed book even to the rest of the staff of the bank. 
Our federal and state banking laws were not adapted to the financing 
of foreign trade,—indeed, they were none too satisfactory even for 
the needs of domestic trade. Practically all of the small amount of 
foreign trade that we had was financed through our banking connec- 
tions in European countries, chiefly in England. Few articles and 
governmental reports and still fewer American books on foreign trade 
and foreign exchange were available to those desirous of learning the 
technique and the practices involved. Foreigners, mostly of English 

I 


2 DOMESTIC AND FOREIGN EXCHANGE 


or German birth and training, dominated the field in the United States. 
Both England and Germany were competing for the mastery of the 
seas. Their exporting and importing firms and their banking houses 
had connections and branches in all parts of the world. Goods had 
to be paid for, credits had to be established, gold and silver had to be 
shipped about from one country to another;—in short, trade had to 
be financed in the most profitable and easy manner, so that it was 
to be expected that expertness in the handling of exchange trans- 
actions would characterize English and German bankers. The World 
War, however, literally forced us into the field, and our expanding 
foreign trade, coupled with our more extended international relations, 
compelled our bankers, import and export managers, investors and 
speculators, to learn something of the intricacies of foreign exchange 
methods. Today increasing numbers of American young men are 
training for a career in the realm of foreign trade and its financing; 
universities are offering courses in various phases of the subject; books? 


1For many years the only outstanding volume on foreign exchange was ‘‘The Theory 
of Foreign Exchanges,”’ by Viscount George J. Goschen, published in 1861. It has run 
through many editions and has been widely translated. It is still the classic treatise on 
the subject, especially on the theory of the exchanges. Another standard English volume, 
likewise of many editions, is ‘‘The A B C of the Foreign Exchanges,” by George Clare 
(London, 1892). Mr. Clare is also the author of ‘A Money Market Primer and Key to 
the Exchanges”’ (London, 1891). Both of these volumes are excellent though brief. ‘‘ Money 
Changing” (London, 1913) and ‘‘War and Lombard Street”? (London, 1915) by Hartley 
Withers are undoubtedly the best available popular discussions of the field by an English- 
man. ‘‘Foreign Exchange and Foreign Bills” (London, ro15), by W. F. Spalding presents 
a most complete and satisfactory treatment of the subject. Mr. Spalding’s ‘‘ Eastern Ex- 
change, Currency and Finance” (2d edition, London, 1920) is also to be highly recom- 
mended as is also T E. Gregory’s volume on ‘Foreign Exchange before, during, and 
after the War” (London, 1921). 

American publications have been much later in appearing. In 1902 the Financier Com- 
pany of New York issued a small volume entitled “‘ Foreign Exchange.’ It was not a very 
successful attempt to cover the fundamentals of the subject. ‘‘International Exchange,” 
by A. W. Margraff (Chicago, 1903) and “Foreign Exchange Textbook,” by Howard K. 
Brooks (Chicago, 1906) long remained the standard American volumes. ‘‘The Elements 
of Foreign Exchange,” by Franklin Escher (New York, 1910) was the first satisfactory 
attempt with us to popularize the subject. In 1917 Mr. Escher published another small 
volume, ‘‘Foreign Exchange Explained”? (New York). Both of these discussions are ex- 
cellent, but naturally, being popular in character, they do not go deeply into the subject. 
Approximately one-half of ‘International Trade and Exchange,” by H. G. Brown (New 
York, 1914) is devoted to foreign exchange, and has been subsequently reprinted under 
the title of ‘“‘Foreign Exchange”? (New York, to15). The treatment is scholarly but ex- 
tremely brief for the student or layman. A much more satisfactory textbook is ‘‘ Domestic 
and Foreign Exchange,” by E. L. S. Patterson (New York, 1917), although again the treat- 
ment is necessarily too brief. By far the best volume on the subject is “‘ Foreign Exchange,” 
by A. C. Whitaker (New York, 1919). It is scholarly, practical, and clearly written. Other 
volumes that may be mentioned are “‘ Foreign Exchange, Theory and Practice,” by T. York 
(New York 1920), ‘‘Problems in Foreign Exchange,” by J. M. Shugrue (New York, 1920), 
and ‘‘Modern Foreign Exchange,” by V. Gonzales (New York, 1914, revised, 1920). Tables 
which may be used for figuring foreign exchange rates, may be found in Brooks, ‘‘ Foreign 


INTRODUCTORY 3 


and articles are being published, lectures delivered, and govern- 
mental documents issued as never before, so that to the observer 
foreign trade and foreign exchange appear to be riding on the crest of 
a wave of popularity. American exporting firms have added ex- 
change experts to their staffs. Banks that never before thought of 
foreign exchange transactions now advertise in their local papers that 
they are able to furnish exchange on almost any part of the world. 
The larger metropolitan banks have established branches abroad or 
have arranged a far-flung system of correspondents, so that they are 
able to reach practically all corners of the globe for the purpose of 
putting through almost any sort of moneyed transaction. Local news- 
papers carry exchange quotations while the more important and 
serious financial journals publish columns of exchange rates with 
complete analyses of the exchange market. National and state bank- 
ing laws have been modified so as to enable both domestic and foreign 
trade to be financed in an up-to-date and much more satisfactory 
manner than was formerly possible. We hear much of the United 
States becoming a creditor nation. The balance of trade, the pay- 
ment of international debts, the importation of gold, the development 
of a discount market in the United States, and many similar subjects 
have become topics of current comment, even in circles outside of 
the banking and trading worlds. Because of these things there has 
arisen a real and sincere demand for the diffusion of information con- 
cerning exchange matters. Therein alone lies the justification for the 
publication of this volume. 

Foreign exchange has always seemed to be shrouded in mystery. 
The possible reasons are two. One is that the average student or 
man of affairs who strays into the field is ignorant of ordinary credit 
transactions and knows nothing or practically nothing as to how claims 
are settled between creditor and debtor without the use of money. 


Exchange Textbook”’; Margrafi, ‘“‘International Exchange’’; Gonzales, ‘‘Modern Foreign 
Exchange”; E. D. Davis, “‘ Foreign Exchange Tables’’ (Minneapolis, 1912); J. H. Norman, 
“Norman’s Universal Cambist’’ (London, 1897); C. A. Stern, “‘Arbitration and Parities of 
Foreign Exchange” (New York, 1902); and Tate’s “‘Modern Cambist”’ (there are several 
editions of this, one by H. Schmidt, London, 1903, still another by H. T. Easton, 24th 
edition, London, 1908). No mention need be made of the large number of volumes issued 
in foreign languages. 

Many American banks have published pamphlets and shorter studies dealing with the 
financing of foreign trade. These are for the most part fleeting documents and need not 
be listed. 

The Commercial and Financial Chronicle and the Annalist, both of New York, contain 
weekly summaries and analyses of the exchange markets. 


4 DOMESTIC AND FOREIGN EXCHANGE 


The other is that foreign exchange implies a knowledge of the 
monies of foreign nations,—for one no longer talks of dollars and 
cents but of pounds sterling, francs, yen, marks, etc. If one first 
becomes acquainted with the practices and devices employed in 
paying bills at home by means of credit transactions, and then 
applies those same principles to the foreign field, and if at the 
same time he merely translates dollars into the money of the foreign 
country concerned, he will have no serious difficulty in treading the 
devious trails of the field of foreign exchange. The principles that 
underlie both domestic and foreign exchange are the same, although 
at times the practices followed and the instruments employed are 
decidedly different in character. 

In line with the suggestions just outlined, I shall first discuss in a 
general manner the fundamentals or bases of credit transactions as 
they facilitate the payment of bills between individuals, business 
firms, or banks located in different communities in one country. I 
shall then take up in greater detail the numerous practices and prin- 
ciples involved in settling such obligations. When a man pays a 
grocery bill or buys a new suit of clothes from his local dealer, he is 
not concerned with the practices of domestic exchange. But when a 
man in San Francisco wishes to pay a bill in New York, or when a 
bank in Seattle desires to pay a debt in New Orleans, or to collect 
money owing it by a Boston firm, or to establish a deposit or credit with 
a Baltimore bank, then the question arises “ How shall it be done?” 
It is this sort of financial transaction, involving the use of credit 
arrangements or the shipment of gold or money, with which domestic 
exchange is concerned. 

After a discussion of domestic exchange I shall pass on to the ques- 
tion of how creditors in one country and debtors in another settle 
their financial obligations. Suppose that an American owes a bill 
in England, or desires to get funds with which to travel in France, 
or wishes to speculate in the exchanges of foreign countries, or plans 
to import goods from abroad, or to collect money owing him by a 
resident of Brazil, or suppose that a bank wishes to engage in financial 
deals of various sorts in other countries or with citizens or banks of 
those countries,—how are all of these and similar transactions carried 
through? What are the mechanism, the practices, the underlying 
principles, and the theories involved? These are matters lying within 
the province of foreign exchange. By approaching the discussion of 


INTRODUCTORY 5 


foreign exchange in this manner I hope to make it possible for the 
reader to understand the fundamentals of the subject more easily 
than is usually the case. 

The details of the technique of domestic and foreign exchange are 
sO numerous, and in some connections so complicated, that it is 
practically impossible at times to discuss certain phases of the subject 
without using terms that have not previously been defined or men- 
tioned in the text. It will frequently be necessary to state that certain 
matters will be more fully discussed in a later portion of the volume. 
An effort has been made, however, to develop the subject logically 
and in such a manner that a minimum of confusion may arise in the 
mind of the reader. 


CHAPTER II 
INTER-BANK RELATIONS 


Ordinarily Jones in Chicago who owes $1,000 to Smith in Los 
Angeles will not ship actual money, either paper or metallic, to meet 
his obligation. Once in a while a person paying a small domestic 
debt will place paper money or a still smaller sum of metallic money 
in an envelope and mail it to his creditor. Asa rule, however, a credit 
instrument of some sort will be used. Again, if Jones in Chicago owes 
£50 to Pratt in London, he will not ship fifty pounds sterling of gold 
to Pratt, nor will he send him fifty pounds sterling’s worth of American 
money. He will be compelled to resort to some kind of credit instru- 
ment with which to make the payment. It is not surprising, there- 
fore, to learn that we finance or pay for about ninety per cent of our 
domestic trade by means of credit instruments, while practically all 
of our international payments are so made. ‘The first matter there- 
fore that has to be clearly understood concerns the arrangements that 
exist by means of which Jones may be supplied with or make use of 
such credit instruments. 

The bulk of domestic and foreign payments could not be made 
were it not for the accommodations provided, and for the services 
rendered, by our banking and other financial institutions. These 
services are made possible by extensive and sometimes very complete 
and detailed relationships which banks and exchange dealers of all 
kinds establish with one another. Banks in Minneapolis must have 
representatives in New York to handle New York deals for them. 
Likewise banks in New York or Seattle must have representatives in 
Chicago, San Francisco, and other important centers to do many 
things for them. American banks must make arrangements with 
banks abroad so that their foreign financial interests and operations 
may be satisfactorily handled and cared for. Sometimes these relation- 
ships are of a purely reciprocal character, i. e., what one bank agrees 
to do for another without charge, the latter agrees to do for the former 
without charge. More frequently, however, slight charges are made 


for services rendered. These bank inter-relationships constitute what 
6 


INTER-BANK RELATIONS 7 


is known as a system of “bank correspondents.”’ The details of such 
correspondent relationships and their effect on exchange transactions 
will be discussed in detail in subsequent pages. 

Thus it is that our large banks and financial houses have corre- 
spondents in practically every city of consequence in the United States 
and also in foreign countries. Some also have their own foreign 
branches. At this writing (May, 1922) the American Express Com- 
pany, besides having about 75,000 agencies and offices in the United 
States, has thirty-five foreign branch offices and subsidiaries as well 
as more than 10,000 banking and shipping correspondents elsewhere 
throughout the world. The National City Bank of New York, with 
its subsidiary, the International Banking Corporation, has 83 foreign 
branches and more than 3,000 foreign correspondents. Other large 
financial concerns such as The Guaranty Trust, The Bankers Trust 
Company, The American Foreign Banking Corporation, J. P. Morgan 
and Company, The Equitable Trust Company, The Asia Banking 
Corporation, The Mercantile Bank of the Americas, and many others 
have branches in foreign countries,! to say nothing of their hundreds 
or even thousands of correspondents, which form a network of relation- 
ships reaching the more important countries and facilitating trans- 
actions of all sorts concerned with foreign financing. Likewise, 
European banks have their branches and correspondents in various 
places. English and German owned banks have been especially active 
in this regard, some having as many as a thousand or more branches 
in addition to several thousand correspondents.” It is this system 
of branch banking that has been of such vital importance in obtaining 
for England her control over foreign trade. And in passing, it may 
not be out of place to remark that if the United States wishes to make 
real progress in building up its foreign trade, it must make it both 
possible and profitable for American banks to establish branches 
abroad. Some steps have already been taken in this direction through 
the revision of our state and federal banking laws.* 


1Quite a number of these branches were discontinued in 1920-21. 

2 Cf. footnote 1, p. 112; footnotes 3 and 4, p. 113. 

3 The revision of state and federal banking laws since 1913 has made possible the use of 
the bank acceptance in the financing of foreign trade. The establishment of the Federal 
Reserve system enabled an open discount market of growing proportions to be brought 
into existence. The Federal Reserve Law also permits national banks under certain 
conditions to establish foreign branches. The passage of the Edge Act by Congress (De- 
cember 24, 1919) provided for the organization of corporations which may engage in foreign 
trade and undertake the long-time financing thereof through the issuance of securities 
based upon acceptances, collateral trust notes, etc. Other changes in state and national 


8 DOMESTIC AND FOREIGN EXCHANGE 


Banks in our smaller cities arrange with banks in the more important 
financial centers to make use of the latter’s correspondents to a limited, 
sometimes to an unlimited, extent in connection with either domestic 
or foreign transactions. The usual requirement is that the former 
must keep an account or deposit with the latter, either large or small 
as the case may be. Ordinarily an interest rate of about two per cent 
is paid on the average balance so maintained. The interest rate on the 
balances kept by American banks with European correspondents 
varies, usually in accordance with the discount rate of the central 
bank of the foreign country. 

A bank in St. Louis, for example, wishing to have the facilities 
which come from a system of domestic and foreign correspondents, 
makes arrangements to that end with a bank in New York. It agrees 
to keep an account or deposit with the latter and to notify the latter 
by means of “advices” of all transactions which it puts through. 
An “advice” is merely a printed or written statement showing what 
has been done, which is sent to the correspondent bank as a notice 
or notification of the transaction. Advices are widely used in con- 
nection with all sorts of domestic and foreign exchange operations. 
Copies of typical advices will appear in subsequent pages. The re- 
lationship entered into gives the St. Louis bank exchange connections 
with a large group of American and foreign banks, but always through 
the agency of the New York bank. The New York bank, in its turn, 
keeps accounts with certain banks in the more important cities in the 
United States and in foreign countries, and when it draws on its 
accounts for exchange purposes it likewise uses advices to notify the 
bank drawn on as to the details of the transaction. 

The question that immediately arises is, “ How are such accounts 
established, and how are they replenished from time to time so as to 
enable banks to make use of their correspondent relations in trans- 
acting their exchange business?”’ 

It would, of course, be expensive and risky for banks to send actual 
money or gold to each other in order to create or replenish their ex- 
change accounts, although this is sometimes done, as will be noted 
later. It is not customary, however, and occurs only when banks find 
it cheaper to ship gold or money than to use various forms of credit 
instruments. 


banking legislation have made it possible for banks to take a much more active part in 
the financing of foreign trade in various ways that were formerly prohibited. 


INTER-BANK RELATIONS 9 


Today, if a buyer wishes to pay a bill of ordinary amount to a party 
located in another section of the country, he will as a rule merely 
draw a personal check on his bank account and forward it to his 
creditor. The latter cashes it or deposits it to the credit of his account 
with his local bank. In order that the check may be collected and the 
amount actually deducted from the bank account of the buyer, it is 
necessary that the check find its way back to the bank upon which it 
has been drawn. Thus, if Jones of Chicago draws a check for $1,000 
on his account with the Chicago State Bank and sends it to Smith 
in Los Angeles, Smith may deposit it with the Los Angeles National 
Bank and be credited with that sum or be given the $1,000 in actual 
cash. The Los Angeles National Bank, let us say, has an account 
with the San Francisco Commercial Bank, which it desires to replenish. 
It forwards the check to the latter with the request that it be credited 
with that sum. The San Francisco Commercial Bank then credits 
the Los Angeles National Bank with $1,000, making it possible for 
the latter to draw drafts on the account or to use it in any manner 
that the Los Angeles bank may desire. In its turn the San Francisco 
Commercial Bank may send the check to the Continental Bank of 
Chicago. The Continental Bank of Chicago will collect the $1,000 
from the Chicago State Bank and credit the San Francisco Commer- 
cial Bank with that sum. Finally the Chicago State Bank will deduct 
$1,000 from the account of Mr. Jones and return the canceled check 
to him. Thus it is that the Los Angeles National Bank has added 
$1,000 to its account with the San Francisco Commercial Bank, and 
the San Francisco Commercial Bank has added $1,000 to its account 
with the Chicago Continental Bank. Both of these banks may use 
their accounts built up in this manner for the benefit of themselves 
or to satisfy the needs of customers who may at any time desire to 
obtain any of a number of different kinds of exchange instruments. 

Another typical method of creating or replenishing such accounts 
is the following:—Let us say that Andrews of Los Angeles has sold 
a bill of goods to Sargent in Boston. He draws a draft on Sargent, 
attaches his shipping documents,’ and sells the bill of exchange to the 
Los Angeles National Bank. The Los Angeles National Bank may 
then send the draft and documents to the Boston State Bank for 
collection and credit. The Boston State Bank collects the amount 


1 Draft and shipping documents constitute what is known as a documentary bill of ex- 
change. 


Xe) DOMESTIC AND FOREIGN EXCHANGE 


of the draft from Sargent and credits the sum to the account of the 
Los Angeles National Bank which may use it as desired. The em- 
ployment of drafts in such connections will be more fully explained 
later. 

It is by such simple means that funds are shifted about from place 
to place, and accounts are created for exchange and other purposes. 

The same principles apply in building up foreign accounts. Let us 
say that the Old Colonial Bank of New York desires to create or to 
build up an account with Barclay’s Bank of London so that it may 
have the use of the latter in accordance with the terms of the corre- 
spondent agreement entered into by the two banks. Suppose that 
Mr. Andrews of New York has sold a bill of goods to Mr. George in 
London amounting to £500 and has drawn a demand draft (a draft 
payable at sight) on him for that sum. Andrews may sell that draft 
and the accompanying shipping documents to the Old Colonial Bank 
of New York, which in its turn transmits them to Barclay’s Bank 
of London for collection and credit. The draft will be collected by 
Barclay’s Bank from Mr. George and the sum placed to the credit 
of the Old Colonial Bank of New York. The latter may then use the 
account thus built up by selling exchange against it. 

In foreign exchange, as well as in domestic exchange, the most 
customary method of creating and replenishing accounts is through 
the forwarding of checks, drafts, and other bills of exchange for col- 
lection or discount. Other methods are employed, but they are of 
minor importance and will be discussed incidentally in subsequent 
chapters. If at any time a bank finds that it can shift its funds or 
build up its accounts by cheaper methods than the ones usually em- 
ployed, it does so. It must be remembered that in all exchange trans- 
actions, both domestic and foreign, the bank is in business to make 
profits for its stockholders. It is this fact that accounts for many of 
the practices followed by means of which a slight saving of interest 
or of funds may be accomplished. It is this fact also which accounts 
for the continued improvement in exchange methods and the develop- 
ment of new ways of handling the various operations. 

Having briefly reviewed some of the practices followed in building 

1“Thus an active bank at any given date may have hundreds or even thousands of 
outstanding loans on foreign trade transactions, some of which are due and paid every 
day, and, in consequence, afford a renewed supply of funds for new transactions.” F. H. 


Sisson, Annals of the American Academy of Social and Political Science, March, 192t 
(vol. XCIV), p. 150. 


INTER-BANK RELATIONS br 


up accounts and in establishing correspondent relations, we may 
now sketch the fundamental methods employed in making use of 
such relations. Reverting again to our example of the St. Louis 
and New York banks, let us say that the St. Louis National 
Bank is approached by a customer who desires to obtain a draft on 
a New York bank with which to pay a bill in that city. The St. Louis 
bank merely draws a draft on its account with the New York bank, 
say the Guaranty Trust Company, and hands the draft to its customer, 
who mails it to his creditor in New York. The creditor presents it 
to the Guaranty Trust Company or cashes it at his own New York 
bank, which in its turn presents it to the Guaranty Trust Company, 
and the account of the St. Louis National Bank is debited with the 
amount of the draft, the canceled draft thereupon being returned to 
the St. Louis National Bank. 

Let us now say that the Guaranty Trust Company has established 
correspondent relations with Barclay’s Bank in London, and that a 
customer desires to pay a bill of £500 in London. The Guaranty 
Trust Company will draw a draft in pounds sterling, not in dollars, 
for £500 and sell it to the customer for a certain sum of American 
dollars. If the price of the pound in New York (the sterling rate of 
exchange) on that day happens to be $4.86, the customer will have to 
pay the Guaranty Trust Company the sum of $2,430 (4.86 X 500). 
The draft will be made payable to the London creditor, who, when he 
receives it from the American debtor, will cash it at his own bank or 
at Barclay’s and receive £500 therefor. The London account of the 
Guaranty Trust Company will thereupon be debited with that 
sum. 

Thus far the procedure appears to be fairly simple; but let us go 
a step farther and have a customer ask the St. Louis National Bank 
for a draft for £100 with which to pay a bill in London. Suppose that 
the St. Louis bank has no account in London, but that it has arranged 
with the Guaranty Trust Company to use the London account of the 
latter, which is on deposit with Barclay’s Bank, London, for all sterling 
exchange purposes. The Guaranty Trust Company will have furnished 
the St. Louis bank with the required printed forms. It also keeps the 
St. Louis bank advised daily as to the rates it will charge the latter 
for all exchange drawn. Thus daily either by mail or by wire it sends 
to the St. Louis bank a list of the different rates of exchange at which 
it is authorized to draw against the foreign accounts of the Guaranty 


12 DOMESTIC AND FOREIGN EXCHANGE 


Trust Company. Suppose that the rate on the list for sight drafts on 
London happens to be 4.87. The St. Louis bank may charge the cus- 
tomer $4.88 for every pound purchased or a total of $488 for the £100 
draft. The customer will mail the draft to his creditor in London, 
who will cash it at his bank and receive his £100. When the draft 
reaches Barclay’s Bank, it will be paid out of the account of the 
Guaranty Trust Co. When the St. Louis bank hands the £100 draft 
to the customer, it sends an “advice” to the Guaranty Trust Com- 
pany stating that on the day in question it sold a £100 draft on Bar- 
clay’s Bank, payable to a certain party, whose name is given, and that 
the rate at which the draft had been drawn, as per the rate list fur- 
nished by the Guaranty Trust Company, was 4.87. The Guaranty 
Trust Company is not interested in the rate that the St. Louis bank 
charges the customer—but only in the fact that the St. Louis bank 
draws on it at the rate of 4.87. When the advice reaches the Guaranty 
Trust Company, the account of the St. Louis bank is debited to the 
extent of $487 (100 x 4.87). The rate of exchange quoted the St. 
Louis bank includes a profit for the Guaranty Trust Company, so that 
the New York account of the St. Louis bank is debited only to the 
extent of $487. The Guaranty Trust Company then sends an advice 
to Barclay’s Bank that the draft in question has been drawn, that it 
will soon appear for payment, and that Barclay’s is to pay it and debit 
the London account of the Guaranty Trust Company with the sum 
of £100. This is the more customary procedure, although sometimes 
the New York bank authorizes the drawing bank (in this case the St. 
Louis bank) to notify the foreign bank directly as well as to send a 
copy of the advice on to New York. 

The above pages briefly describe in a general manner the methods 
employed in building up and in making use of correspondent relations 
in exchange transactions. Many details remain to be explained but 
they will be taken up as the discussion proceeds. For our immediate 
purposes this birdseye view of the situation is sufficient. 

The exact terms of the agreements under which the correspondent 
relations are carried on are sometimes embodied in a several page, 
printed or typewritten, document which holds until amended or 
changed by subsequent instructions. Especially in the field of foreign 
dealings does such a document play an important part because of the 
distances separating the correspondents and the time that it takes to 
get in touch with one another concerning any financial matter. The 


INTER-BANK RELATIONS 13 


following is typical of such agreements between American and foreign 
correspondents :— 


CONDITIONS FOR THE ACCOUNT OF THE 


BOSTON STATE BANK, BOSTON, MASS. 


with the 


PROVINCIAL BANK, ANTWERP, BELGIUM 


ACCOUNT. 
INTEREST. 


COLLECTIONS. 


DRAWINGS. 


PAYMENTS. 


Commission Franco. 
Credit: until further notice 3%. 
Debit: 1% over the National Bank Rate. Min. 5%. 
Clean Bills: 
Antwerp 
Brussels Franco. Value day of payment. 
Ostend 
Other towns in Belgium: fr. 0.50 per bill. 
Value 3 days after payment. 
Documentary Bills: 


Antwerp 14 o/oo. Min. fs. 2.50. 
Brussels Value day of payment. 
Ostend 


Other towns in Belgium: 14 o/oo. Min. frs. 2.50. 
Value 3 days after payment. 
A special commission may be charged on bills on out-of-the- 
way places. 
On our offices or on our agents: Franco. Value date of re- 
ceipt of advice. See list of correspondents attached. 
Clean: 
Antwerp — 
Brussels At our offices. 
Ostend 
To banks or large mercantile houses: Franco. 
To private parties at their domiciles: 14 0/00. 
Documentary: 


Antwerp 
Brussels 1% o/oo. Min. frs. 2.00. 
Ostend 


Under travelers’ letters of credit: 
Expressed in currencies other than Belgian francs: 
Franco. 
Expressed in Belgian francs: 1/8%. Min. fr. r. 


14 DOMESTIC AND FOREIGN EXCHANGE 


CREDITS. Sight: See clean payments. 
Documentary: See documentary payments. 
Confirmed: 1% o/oo. Min. frs. 2.00, additional. 
ACCEPTANCES. For your account: 
1%% for 3 months. (Subject to arrangements.) 
VALUE Dates. Payments to your account: 
Same day if effected before noon. 
Monies paid to the debit of your account: 
Same day. 


The above agreement covers the conditions of an account which 
the Boston State Bank has opened with the Provincial Bank of 
Antwerp, Belgian. The account is in terms of the money of that 
country, i.e., Belgian francs. The Boston bank is to receive an inter- 
est rate of 3 per cent until further notice on its balance or account with 
the Antwerp bank. This interest rate varies with the official discount 
rate ' of the central bank (the National Bank of Belgium). If per- 
chance the Boston bank overdraws its account, it will be compelled 
to pay a minimum charge of 5 per cent on such overdrafts, but a 
charge of at least one per cent over the central bank’s (the National 
Bank of Belgium) official rate of discount. 

In choosing a correspondent abroad, bankers deem it advisable to 
select a bank that has a large number of branches and whose corre- 
spondents make the least charges, not a bank that allows the greater 
rate of interest on credit balances. 

If the Boston bank send bills of any sort to be collected by the 
Provincial Bank, they will either be clean bills, i. e., having no docu- 
ments attached ? or documentary bills, i. e., having documents at- 
tached.* For example, the Boston bank may have a customer who 
has presented to it a bank draft, received from a Belgian debtor, for 
1,000 francs drawn on a bank in Brussels. The Boston bank may have 
paid the customer a certain number of American dollars for that 
franc draft. It forwards the draft to the Provincial Bank of Antwerp, 
which collects from the Brussels bank and credits the Boston bank’s 
account with the amount of the draft. The Boston bank may receive a 
number of similar bills to be collected from Belgian banks. For all 
clean bills drawn in francs to be collected from banks in Antwerp, 


1Cf. pp. 402-406 for discussion of official discount rate of the Bank of England. 
2 Cf. pp. 63, 139 for discussion of clean bills. 
®°Cf. pp. 61-62, 140 for discussion of documentary bills. 


INTER-BANK RELATIONS tS 


Brussels, and Ostend, the Provincial Bank makes no charge for 
collection and credits the account of the Boston bank as soon as the 
bills are collected, i. e., “value day of payment.”’ On other towns, 
clean bills are collected at the charge of a half franc per bill and credit 
given the Boston bank three days after payment. Documentary 
bills are collected on the three cities mentioned at a charge of 1/40 per 
cent of the face value of the bill (1/4 per mille), with a minimum charge 
of 2 1/2 francs, and credit given on day of payment. On other towns 
the charge is 1/20 per cent with the same minimum charge and with 
credit three days after payment. In the case of out-of-the-way places, 
a higher charge may be imposed. 

The Boston bank is authorized to draw franc drafts on any of the 
offices of the Provincial Bank of Antwerp or its agents, and its (the 
Boston bank’s) account is debited upon the receipt of the advice 
relating to the transaction. 

If the Boston bank draws clean bills on the Provincial Bank, they 
will be paid in Antwerp, Brussels, or Ostend and to banks or large 
mercantile houses without the deduction of exchange charges, but 
if made payable to private parties in cities where the bank has no 
branches, an exchange charge of 1/20 per cent is made to the Boston 
bank for the service rendered. Documentary bills drawn against 
the Provincial Bank will also be charged against the account of the 
Boston bank at the rate of 1/20 per cent with a minimum charge of 2 
francs. There is no charge for travelers’ letters of credit } issued by 
the Boston bank on the Provincial Bank, provided they are issued in 
terms of foreign currency because the Provincial Bank in those cases 
will make a profit in cashing the drafts drawn in foreign monies. But 
if travelers’ letters of credit are drawn in Belgian francs, the Provin- 
cial Bank is compelled to pay the full amount of the drafts and will 
therefore get its commission or profit by charging the account of the 
Boston bank 1/8 of 1 per cent (minimum charge of 1 franc) on the face 
value of each draft cashed. For “confirming” a commercial letter of 
credit 7 a charge of 1/20 per cent is made plus a minimum additional 
charge of 2 francs. For assuming the responsibility of accepting drafts 
drawn against it under commercial letters of credit, it will charge the 
Boston bank, on the average, 1/4 per cent on three months’ drafts. 
This rate may be modified under certain conditions. Some of these 


1Cf. pp. 223-233 for discussion of foreign travelers’ letters of credit. 
2 Cf. pp. 257, 284-287 for discussion of confirmed letter of credit. ° 


16 DOMESTIC AND FOREIGN EXCHANGE 


terms may be confusing to the beginner but all of them will be more 
fully defined and described in later pages. 

Finally, when items come to the Provincial Bank to be credited 
to the account of the Boston bank, the latter is given credit on the 
same day if they arrive before noon; if not, on the next day. ‘In the 
case of items being presented for payment from the account of the 
Boston bank, the Provincial Bank debits the account of the Boston 
bank with those amounts on the day when paid. 

The commissions charged American banks by foreign correspondents 
are a matter of negotiation, the rate usually varying “with the volume 
and the nature of the transactions—the larger the account the cheaper 
the rates.”” The customary scale of charges imposed by London banks 
will approximate the following: handling documentary bills, about 
1/40 of 1 per cent; cashing drafts drawn under travelers’ letters of 
credit, about 1/40 of 1 per cent; accepting drafts drawn under com- 
mercial letters of credit, about 1/16 of r per cen per month of us- 
ance; confirmation of commercial letters of credit, from 1/8 to 1/20 
of r per cent; accepting long bills drawn by the American bank, about 
1/16 of 1 per cent per month of usance. Instead of a commission 
being charged on each item handled for the American bank, a flat 
commission may be levied on all items credited or debited to the ac- 
count of the latter, excluding only acceptances. Such flat rates vary 
from 1/40 to % of r percent. Or still another form of “arrangement 
is for the American bank to pay a lump sum periodically for the total 
service; this arrangement makes for simplicity, frees the business 
from special commission charges, eliminates the clerical work of 
recording in detail the different commission charges, gives the Ameri- 
can bank interest on its full balance, and saves correspondence over 
petty details. This lump charge varies, of course, with the average 
volume of business that the account occasions, and is accordingly 
readjusted from time to time by contract.” ” 

Agreements covering correspondent relations between domestic 
banks contain clauses of the same general nature as those that are 
found in the foreign field. The following is oe and needs no ex- 
planation: 


1Cf. Appendix I for another form of correspondent relations agreement. 
2 Westerfield, R. B., “‘Banking Principles and Practice,” New York, 1921, p. 1138. 


INTER-BANK RELATIONS 17 


CONDITIONS OF ACCOUNT 
WITH 


THE MERCHANTS NATIONAL BANK OF LOS ANGELES 


WE Desit You: 
ACCOUNT: 
INTEREST: 
DRAWINGS: 


PAYMENTS: 


COLLECTIONS: 


‘TRANSFERS 
ON Book: 


WE Crepit You: 


INTEREST: 


REMITTANCES: 


LOS ANGELES, CALIFORNIA 


Free of commission. 
1% above Federal Reserve Bank rate, minimum 6%. 
On Us and Our Correspondents by you and your friends: 
In Dollars: Free of commission, value date of payment. 
In Other Currencies: Free of commission. In reimburse- 
ment will draw on you or as you may instruct 
otherwise, with canceled vouchers attached. 
Drafts must bear the clause: ‘At drawee’s buying 
rate for bankers checks on......... ‘ig 
Under Telegraphic or Mail Advices: To Banks, Mer- 
cantile Houses and Private Parties throughout the 
United States, free of commission, value date of 
payment, plus actual costs. 
Against Documents or under Unconfirmed Credits: 1/16% 
And Acceptances under Confirmed Credits: Sight 1/16% 
30 days 1/8% 
60 & godays 1/4% 
Under Travelers’ Letters of Credit: Both Dollars and 
Other Currencies, free of commission. 
Clean and Documentary: 
On Los Angeles, free of commission. 
On Other Cities, at actual cost to us. 


Free of commission. 


244% per annum, on average daily balances, credited 
monthly, until further notice. (Excepting items 
under deferred credits.) 

Clean and Documentary: Items payable in Los Angeles 
if received before 3 P. M. will be credited the same, 
otherwise the next day. 

Items drawn on other places will be credited on a de- 
ferred basis ranging from two to ten days (San 
Francisco 2 days, Seattle 3 days, Chicago 4 days, 
New York 5 days, etc.) 


18 DOMESTIC AND FOREIGN EXCHANGE 


SPECIAL CONDITIONS AND REMARKS: 

INTEREST ON TERM ACCOUNTS: 3% if left for three months, 4% if left six 
months. 

DISCOUNT: Of fine long bills payable in the United States at best 

rate. 

FOREIGN EXCHANGE TRANSACTIONS: We are constant buyers and sellers of 
foreign exchanges at best rate obtainable. 

INFORMATION: Regarding the credit standing of firms and individuals, 
free of charge. 

ACKNOWLEDGMENT: Of remittances is made each time by letter and state- 
ment of account is furnished at the close of each 
month. 


The larger metropolitan bank or exchange dealer, whose domestic 
or foreign accounts are used by correspondent banks for exchange 
purposes, usually issues a set of instructions to the latter as. to just 
how drawings are to be made. These instructions are frequently of a 
very detailed character, being necessarily of that nature because of 
the lack of information and training concerning exchange matters 
which characterizes bankers and bank employees in our smaller towns. 
The following is typical of such documents: 


THE MERCHANTS NATIONAL BANK 
of Los Angeles 


GENERAL INSTRUCTIONS 
FOR DRAWINGS UNDER OUR PROTECTION 


Draft Form _ 1. The Merchants National Bank of Los Angeles will furnish 
you upon application books containing drafts and bank post 
remittance forms with your own title printed upon them. 
Checks are to be drawn by you over your own signature and 
for your own account, as we simply act as agents in transmitting 
funds abroad. 

On account of the still existing inefficient postal service 
abroad and in order to insure prompt payment, our foreign 
drafts are in duplicate form, either of the instruments being 
negotiable, which enables the sender to dispatch duplicate by 
next mail boat or upon advice that the original has not been 
received by the payee, without further inconveniencing the 
issuing bank for the issuance of a duplicate. 

Drawing 2. We urgently request that drawings be confined to the 

Places principal cities of the country on which drawn unless the pur- 


Foreign 
Currency 


Post Re- 
mittance 


Rate Sheets 


Advice 


Settlement 


Spoiled 
Drafts 
Repurchase 
of Drafts 


Dollar 
Drafts 


INTER-BANK RELATIONS 1g 


chaser insists upon having a check drawn direct upon one of 
the smaller places; in which case you are at liberty to draw 
on any one of the banks mentioned in this book. 

3. Drafts should be issued only in the currency of the re- 
spective foreign country and in a manner indicated at the head 
of the various countries. 

4. We recommend the use of bank post remittance in all 
cases where a remittance is desired payable at a place in Europe 
without proper banking facilities. Under this system the 
payee’s name, address, and amount advised is forwarded to 
our correspondent, who, in turn, remits the money in bank- 
notes by registered and insured mail. When sending a bank 
post remittance to Italy it is necessary to indicate also the 
father’s name of the payee with the prefix “‘DI”’ if living and 
“FU” if dead. Example: “Luigi Angello di Abbateccola”’ or 
“Tuigi Angello fu Abbateccola.”’ 

5. Quotations are mailed daily on numbered rate sheets. 
Always use the last rate sheet on hand. For all drafts in 
excess of our rate sheet limits, special rates will be supplied 
by us by phone or wire. 

6. Advice stubs must be mailed to us on the same day the 
drafts are issued, as our correspondents abroad will honor 
drafts only upon receipt of our advice. 

We acknowledge all advices received. If acknowledgment 
is not received say within 10 days of date of mailing, inquiries 
should be made. 

7. Indicate on the advice whether you are enclosing check 
or wish to have amount charged to your account. 

8. Drafts spoiled should be returned to us marked ‘Can- 
celled;”? 

9. In case a draft is to be cancelled or refunded after pay- 
ment has been made to us, refund will be made only upon sur- 
render of both the original and duplicate at the prevailing 
rate of exchange and not at the rate issued. All drafts sent us 
for purchase must bear your guaranteed endorsement signed 
in ink by an officer duly authorized to sign. 

to. All drafts drawn in Dollars on points outside of the 
United States, or in Pound Sterling on points outside of Eng- 
land, Ireland, and Scotland, or in Francs on points outside of 
France, are to be marked on their face “‘PAYABLE AT THE 
DRAWEE’S BUYING RATE FOR DEMAND DRAFTS 
(ON NEW YORK) (ON LONDON) (ON PARIS)”’ as the 
case might be. 


20 


Cable 
Transfers 


Foreign 
Deposits 


DOMESTIC AND FOREIGN EXCHANGE 


In remitting us for Dollar drafts, please include a charge of 
one-quarter of one per cent commission. Minimum twenty- 
five cents. | 

12. Our facilities to effect quick payment by cable in all 
parts of the world and especially Europe are equal to those of 
any of the great financial institutions in this country. When- 
ever the matter is urgent or when transferring large sums of 
money, we recommend the use of cable (use Special Foreign 
Money Transfer Blanks). 

In selling cable transfers, be governed by the following: 

(a) Send us order by telegraph or mail. 

(b) Remit cover at the cable rate quoted on your last rate 
sheet, plus cable charges which we will assume to 
be on the average of $4.50 for England, France, 
Belgium, Holland, and $5.50 for other European 
countries; $7.50 for countries in South America, and 
$10.00 for oriental points. 

(c) All cable orders reaching us before 4 p.m. Los Angeles 
time will be attended to the same day. 

13. In the past two years we have opened accounts in foreign 
currencies abroad for thousands of our clients to the entire 
satisfaction of every one of them. You are at liberty to call 
upon us for similar services in behalf of your clients, enclosing 
in each case three specimen signature cards. Usually it takes 
about two months to receive a receipt or pass-book from 
abroad. When the depositor chooses to open an account 
with our correspondent abroad, then make checks payable to: 
“Drawee Bank, Account Mr. X. X.” If he chooses some 
other bank, say for instance Hypotheken Bank, Miinchen, 
then make drafts read, “Pay to Hypotheken Bank, Miinchen, 
Account Mr. X. X.” If the draft is already made out in the 
individual’s name, have him make a special endorsement read- 
ing: ‘‘Pay to Société Genérale, Paris for credit of my account. 
Signed X. X.”’ In case a check is lost in the mails, unauthorized 
individuals are not able to cash it if made out in the above 
described manner. 

Withdrawal of such accounts can be effected in the following 
manner: 

(a) A personal check may be drawn against the account 
abroad. 

We shall forward such check for collection abroad and 
make settlement at the current rate of exchange on 
day advice of credit reaches us. 


INTER-BANK RELATIONS om 


(b) We will purchase same outright if same bears the en- 
dorsement of the bank, at the prevailing market. 
It is prudent but not essential that the drawer 
present some evidence that he maintains sufficient 

funds abroad to cover the withdrawal. 
Letters of 14. Our Commercial and Travelers’ Letters of Credit are well 
Credit known throughout the world. We will gladly furnish your 
clients upon request with such Letters of Credit upon cash 
payment or under your guarantee, in Dollars, for a nominal 
charge of 1/8 of 1%, or in other currencies at a fixed rate, or 
at the current rate of exchange upon receipt of payment advice. 
Correspond- 15. All correspondence relative to foreign exchange service 
ence should be addressed to the Foreign Exchange Department. 
Facilities 16. Owing to the fact that our sphere of activity is confined 
only to some 250 banks located in the great Southwest, we 
are in position to render to country friends, using our facilities, 

prompt and efficient service. 

Our connections are very extensive, our operations complete, 
and you may safely entrust us with any foreign exchange 
transaction that may come up. | 

THE MERCHANTS NATIONAL BANK 
OF LOS ANGELES 


FOREIGN DEPARTMENT 


The terms of the above agreement are self-explanatory. If it be- 
comes necessary at any time to modify the terms of either domestic 
or foreign agreements, notices of the changes are sent by mail or by 
wire. 

Naturally it is impossible for a bank to have a correspondent in 
every city in which it may have to put through some sort of financial 
transaction or on which it may have to provide exchange. Banks 
have correspondents only in those cities with which they have the 
greater part of their outside business relations. But if a bank does 
not have a correspondent in a certain town, either at home or abroad, 
and finds it inconvenient or impossible to use one of its already au- 
thorized correspondents, it is customary to wire or write a bank 
located in the city in question, and ask it to act in the desired capacity. 
In this way it is possible for a bank to arrange financial connections 
in practically every country and important city of the world. 


CHAPTER III 
DOMESTIC EXCHANGE 


Domestic exchange concerns itself with the instruments, practices, 
and principles involved in making payments between creditors and 
debtors in different communities of the same country. It is some- 
times known as “inland” exchange, and the instruments with which 
it is concerned are frequently called “inland bills of exchange.” 
Legally, however, an inland bill of exchange is one that is drawn and 
payable within the same state. Under our “Uniform Negotiable 
Instruments Law,” a bill drawn in New York and payable in New 
York is an inland bill of exchange; if it is drawn in New York and 
made payable in St. Louis, it is a “foreign” bill. In this volume, 
however, I shall use the terms “domestic exchange” and “domestic 
vills” in the sense employed in the opening statement of this chapter, 
and the terms “foreign exchange” and “foreign bills” as referring 
to exchange relations between parties in different countries. 

Suppose that Jones of Chicago buys $100 worth of toys from Smith 
in New York. How will he pay for the goods? He may use one of a 
number of methods. He may place $100 of paper, silver, or gold money 
in a package and send it to Smith by registered mail or by express. 
This is very unsatisfactory, unsafe, unnecessarily expensive to the 
sender, and is seldom employed. Usually a credit instrument of some 
kind will be used. Credit instruments are commonly known as 
“bills of exchange.” A bill of exchange is defined by the Uni- 
form Negotiable Instruments Law! as being “an unconditional 
order in writing addressed by one person to another, signed by the 

1 Negotiable instruments, such as checks, drafts, acceptances, etc., play an important 
part in our commercial and financial activities. The laws of the forty-eight states of our 
nation dealing therewith were so confusing and diverse, that the American Bar Association 
drew up a Uniform Negotiable Instruments Law, somewhat similar to that of England, 
and presented it for adoption to the various state legislatures. It has been adopted, with 
but slight modification, by all divisions of our country except Georgia, Hawaii, the Dis- 
trict of Columbia, and the Philippine Islands. It establishes uniform regulations regarding 
the use of negotiable instruments and has been an invaluable aid in facilitating credit trans- 
actions in all parts of our commonwealth. More detailed reference is made to it in Chap- 


ter IV. 
22 


DOMESTIC EXCHANGE 23 


person giving it, requiring the person to whom it is addressed to pay 
on demand or at a fixed or determinable future time a sum certain in 
money to order or to bearer.” 

The means of creating domestic (as well as foreign) exchange may 
be divided into two general groups: (1) those in which a third party, 
such as the postoffice, banks, express companies, telegraph companies, 
etc., supplies the debtor thereby enabling him to satisfy his obligations 


Form No. 6001 


Post Office Department RQ rad te ocekesak sa 


THIRD ASSISTANT POSTMASTER GENERAL __Stamp of Issuing Office 
DIVISION OF MONEY ORDERS 


The Postmaster 
will insert 


here 28 88 8 2 Oe C8 2 Oe © © ST © S OF BF O22 S38 SSST" 
whe office drawn on, when the office named by the 
vemitter in the body of this application is not a Money Order Office. 


Spaces above this line are for the Postmaster’s record, to be filled in by him 


Application for Domestix-Money Order 


Spaces below to be filled in by p: f mecessary, 
by. another person for h mn 


Whose 
Address 
is 


Post 


eumR accra aa Genres ad Beaded J, ae 


© wee Bem oS © ew we ere we wee eee ee OS ee He re eee ee 


PURCHASER MUST SEND ORDER AND COUPON TO PAYEE 
C5—7155 





FIGURE I 
Application for domestic money order 


24. DOMESTIC AND FOREIGN EXCHANGE 


972. 
RECEIPT 


TO BE DETACHED BY THE PUR 
CHASER, WHO SHOULD PRESENT . 
oT AY THE .OFFICE OF issuE WF 
GEGARDING THE CROER 


972 
CEMAL MUMRER 
DOLLARS CENTS 
meuass FoR canTs 
1seyIne OFFICE 


OF THE ORDER AND ANY ALTERA- 


MOT TO BE DETACHED BY MOLOER 
- TION OR ERASURE RENDERS IT VOID 


Coupon for Paying Office 


Brainard, lowa. 


560. 


mu 
THIS MONEY ORDER i8 NOT GOOD 


Payag, WT WORDS FoR DOLLARS 


<i 


: 
° 
2 
: 
5 
z 
ce 
: 
é 


8 INDICATED ON LEFT-HAND MAR 


BNIN S1H1 NO NOSNOD HSV. 


& 


GQ MaLOVNIe: 


z 
x 
ry 


| 


12... 


POSTMASTER AT ANY MONEY ORDER OFFICE 1% THE CONTINENTAL 
UNITED STATES, ALASKA EXCEPTED, WILL PAY IF PRESENTED WITHIN 


Brainard, lowa. 
THIRTY DAYS FROM DATE OF ISSUE 


United States Postal Money Order 


WILL PAY AMOUNT STATED ABOVE TO ORDER OF PAYEE NAMED IN ATTACHED COUPON OF SAME 
RECEIVED PAYMENT: 


NUMBER, IF ISSUED WITHIN THE CONTINENTAL UNITED STATES, ALASKA EXCEPTED, THE 


THE POSTMASTER AT 


Henne eee 


FIGURE 2 
Domestic postoffice money order 





to his creditor, and (2) those 
which are created or brought into 
existence by the creditor himself 
by which he satisfies his claims 
upon the debtor. In the first case, 
the buyer or debtor remits or sends 
a bill of exchange of some kind to 
the creditor which the latter may 
cash at a bank, postoffice, express 
company, or telegraph office, or 
which he may sell to another 
person for money. In the second 
case, the seller or the creditor 


/draws a draft or an order upon 


the debtor or his agent and either 
sends it forward for collection or 
sells it to an exchange dealer. If 
sold to an exchange dealer, it will 
be forwarded and collected by the 
latter or his agent from the debtor. 
Under the first group come such 
kinds of domestic exchange in- 
struments as postoffice and ex- 
press money orders; telegraphic 
transfers made available by tele- 
graph companies, banks, and Fed- 
eral Reserve banks; checks, bank 
drafts, and certificates of deposit 
provided by banks; and. finally 
travelers’ checks and travelers’ or 
circular letters of credit issued both 
by banks and by express com- 
panies. Under the second group 
comes the ordinary or individual 
draft, as distinguished from the 
bank draft, drawn by the creditor 
upon the debtor or upon the finan- 
cial agent of the latter, usually a 
bank, with which the debtor has 


DOMESTIC EXCHANGE 25 


made the necessary arrangements. All these kinds of domestic 
exchange will be described in this chapter. 

Postoffice Money Order. A commonly used type of domestic bill 
of exchange is the postoffice money order. Jones of San Francisco, 
wishing to send $100 to Smith in New York, goes to his local postoffice 
and writes out an “Application for Domestic Money Order ” (Fig. 1). 
The postoffice clerk thereupon fills out the regulation money order 
form which is of three parts (Fig. 2), (a) the stub of the agent of the 
selling office, kept for record, (b) the receipt which Jones may keep 
for future reference, and (c) the order itself which directs the New 
York postoffice to pay $100 to Smith upon identification. Jones 
sends the order to Smith who presents it at the postoffice and gets 
his money, or indorses it and cashes it at his local bank. He may not 
indorse it to another person. Only his own indorsement and that of a 
bank are permitted by the rules of the postoffice money order depart- 
ment. In fact, the indorsement of the bank is not legally an indorse- 
ment, but is looked upon as being the identification of the signature 
of the payee. This naturally limits the negotiability of the order 
and makes it far from satisfactory under many conditions. The order 
may be cashed at any postoffice within thirty days after being issued, 
but after that time it is necessary for Smith to cash it only at the office 
upon which it was issued, i. e., the New York office. Postoffice money 
orders are used primarily for small sums because of their expense.! 
They are seldom used by business men and are usually employed 
only by those who do not have banking accounts. They are bother- 
some because the sender has to go to the postoffice and personally 
fill out the application blank. If the recipient of the order cashes it 
at the postoffice, he has to be identified, which is frequently no easy 
matter because usually he is not acquainted with the clerk in charge 
of the money order department. The maximum amount for which 
an order may be issued is $100, so that if one desires to send more 
than that sum he must obtain additional orders. 

The order itself, as may be noted from Fig. 2, is made up of two 
parts. Once a week the various postoffices cut their cashed orders 


1 The costs are as follows: 


From $0.01 to $2.50...... 3 cents From $30.01 to $40.00...... 15 cents 
ig $2568 10) .$5.00-3740. 5 cents “0 $40.01 to: .$50.00.% 01: 18 cents 
e $5.01 to $10.00...... 8 cents Ses. T 1010 BOLE ete © 20 cents 
PS IO.01 tO $20.00. 7.5... ro cents ©" $60.05 tOmi$7$.00<. « Y.5 25 cents 


“<c 


$20.01 to $30.00...... 12 cents * $75.01 to $100.00...... 30 cents 


26 DOMESTIC AND FOREIGN EXCHANGE 


in two, keep one part for record, and send the other to Washington 
where the receipts and expenditures of the various postoffices are 
checked up and balanced. England inaugurated her postal money 
order business as early as 1839, but it was not until 1864 that the 
United States put its system into operation. During the first year 
our postoffice department sold $1,360,122.52 worth of domestic orders. 
By 1920 this sum had grown to $1,333,045,947.73. For the year 1914” 
the excess of revenues over cost of operation amounted to $10,296.05, 
which, when added to the proceeds obtained from the cancellation 
of unclaimed orders more than a year old ($580,888.85), netted a total 
profit to the government from the sale of domestic money orders of 
$591,184.90. 

Express Money Order. A much more satisfactory and commonly 
used form of domestic exchange is the express money order issued by 
the offices of the American Railway Express Company and by banks, 
business firms, etc., acting as agents of the American Express Com- 
pany. ‘This form of money order was introduced in 1882 by the 
American Express Company. It consists of an agent’s stub, a receipt 
for the sender, and the order itself which is sent to the creditor (Fig. 3). 
The rates for an express money order are slightly higher for smaller 
sums and slightly lower for larger sums than those charged for a post- 
office order.*? An express money order is much easier to obtain than 
a postoffice order because the company’s office or branch office is 
usually more conveniently located than is the postoffice. In applying 
for an express money order, it is necessary to tell the agent only the 
name and address of the party to whom you wish to send the money 
and the amount to be sent. There is no application blank to be made 
out by the sender. The order will be handed to the customer as quickly 
as the agent can fill in the blank spaces. Single orders may be issued 
for any sum up to $50. Ifa customer wishes to send a larger sum he 
must purchase two or more orders. Express money orders may be 
cashed on the usual identification in any place and at any time, and 
do not have to be cashed at the office upon which drawn. They may 

1 The practice of issuing foreign or international money orders, to be discussed later in 
detail, was begun September 1, 1860. 


2 No later data appear available. 
3 Rates for Express Money Orders: 


NOt over S2kos.- eens & cts; Not over 50.007.:. 55. 15 cts. 
Poe hs ie OES Ce ae ae oe wu) ie 695 O00) Aaa rs. S 
SAD Ue atten) Mkt)! lor re RE 0G 008 eee eee 304 


ee ee ee 


BOGE eee Over $100 at above rates. 


DOMESTIC EXCHANGE 


be indorsed any number of times and 
passed from person to person or depos- 
ited with a bank. In case of loss or theft, 
the receipt, as in the case of the postoffice 
money order, guarantees the sender against 
monetary loss. 

Telegraphic Transfers. At times a need 
arises for a more rapid transference of 


funds or payment of money than is af- | 
forded by the use of postal or express © 


money orders. Recourse may then be 
had to a telegraphic order. It is as easy 
to send money by telegraph as it is to 
send a message by wire. Practically any 


part of the United States may be reached : 
in thismanner. Telegraphic exchange may — 
be purchased either through the regular ~ 
The | 


telegraph offices or through banks. 


27 







W3H 30 BRYN 


sor Hem FIFTY COLLARS 
war wae FORTY MOLLARS. 
vax THIRTY DOLLARS. 4 

uct <xan THENTY DDLLARS. 2 J 
‘on Non, ean TEN DOLLARS. © 3 
«more ton FIVE DOLLARS | 





















OM aNerewainod) HA 





a0 wNS 3H, 


B23 


"40 UaQUO IHL OL AV 


CaN OISHSLNNOD NAHM 


BOSS 4D INA IW INBEV AD 





BAD SR ASWNTARY 


principle involved is merely the sending ?,; * 
of a telegram to an agent or correspondent : 


requesting him to pay over to a designated 


party a certain sum of money. The de- u 
tails of the procedure will be brought out 2) © 


in connection with the description of a 
telegraphic exchange transaction, first of 
an express company and second of a bank. 

Jones of San Francisco desires to wire 
$500 to Smith in New York. He goes to 
the telegraph company’s office and fills out 
an application for a domestic money trans- 
fer order (Fig. 4). He may require positive 
evidence of identification from the person 
to whom the money is to be paid or he 
may waive that formality. In the latter 
case the company will have to use due 
diligence and precaution to see that the 
payee (the one to whom the money is to 
be paid) is the proper party. If it uses 
such diligence it cannot be held liable for 





FIGURE 3 
Domestic express money 
order 


28 


DOMESTIC AND FOREIGN EXCHANGE 


Form 72 A 


THE WESTERN UNION TELEGRAPH COMPANY 


INCORPORATED 
NEWCOMB: CARLTON, PRESIDENT 


DOMESTIC MONEY TRANSFER ORDER 


If after the recelpt of this domestic order at the-paying office 
(Ellis Island, N. Y., excepted), payment cannot be made within 72 hours 
(exclusive of Sundays and holidays), the order will be canceled and 
refund made to the sender. Transfers to Ellls Island, if unpaid, will be 
canceled at the expiration of 5 days (exclusive of Sundays and holidays). 


No. 


THE WESTERN UNION TELEGRAPH COMPANY: 
SUBJECT TO THE CONDITIONS BELOW, 


PAY TO 


(The address should be full and clear, If toa woman give prefix Mrs. or 


Miss, if practicable } 


ee ee ee eee ey OATS 
Signature. 


Address. 


When the Company has no office al destination authorized to pay money, it shall 
nol be liable for any default beyond its own lines, but shall be the agent of the sender, 
without liability, and without further notice, to contract on the sender's behalf with any 
other telegraph or cable line, bank or other medium, for the further transmission and 
final payment of this order. 


(c) As the above-named payee may not be able to produce positive 
evidence of personal identily, I hereby authorize and direct The Western 
Union Telegraph Company to pay the sum named in this order, at my 
risk, to such person as the Telegraph Company's Agent believes to be the 
above-named payee. 


Signature 


OMEN 8 ee ne eR ER EE NE EE EE EE SE SE ER 

Note—Should the sender, of the transfer prefer that the payee be 
required to produce the mecessary evidence of his identity, he should 
sign the following: 


(v) The undersigned directs that the above amount be paid only on the 
production by the payee of positive evidence of his personal 
identity. 


Signature 


Principal, §. Time Filed 
Premium, 
Teleg. tolls, 


Total, $ 





FIGURE 4 


Application for domestic telegraphic transfer 


wrong payment. Ifthe 
company has no office 
in the town of the 
payee, it agrees to act 
merely as an agent of 
the sender and to be 
held liable only for any 
default that may occur 
in connection with its 
having acted as_ the 
sender of the message. 

Upon filling out the 
required application 
blank, the sender is 
given a receipt. The 
cost of the telegraphic 
transfer includes the 
cost of the telegram 
(known as “the tele- 
graphic toll” and vary- 
ing according to the 
distance the telegram 
is to be sent), and the 
premium costs. The 
percentage charge for 
the amount remitted 
becomes less as the sum 
sent becomes larger. 
The premium costs are 
the same for all offices 
and range somewhat 
as shown on opposite 
page. 

In sending telegraph- 
ic transfers, codes are 
used in order to pre- 
vent the message being 
intercepted and pay- 
ment being made to 


DOMESTIC EXCHANGE 20 


the wrong party. The sum that may be sent by one order is usually 
limited, depending upon he classification of the city. Offices located 
in large cities are allowed to handle larger amounts than offices in 
smaller cities. Asa rule orders addressed to cities of minor importance 
are sent through a larger city nearby (“transfer cities”’), thus minimiz- 
ing the confusion that would result from having too many sending 
and receiv ng offices with thousands of sending codes. 


TELEGRAPHIC TRANSFER PREMIUM COSTS 


es OO he Me ers. ok, 2.25 
EE aaa 35 
51.00 to 75.00. JSD naitne Min Mees 4 8,8) 
PEO FUEL OO.OO Sekai thse oes a ee aOS 
For each Phaitiondl $100 up to and including $3,000....... $.25 
FP eeac hea Cditiond ls e100. OV T. 3,000.44) 0. a i aye 3s -'e e 220 


When the telegram reaches the receiving office, the latter sends out 
a notice (Fig. 5) to the payee, asking him to appear at the company’s 


Form 75 


THE WESTERN UNION TELEGRAPH COMPANY 


25,000 OFFICES IN AMERICA “CABLE SERVICE TO ALL THE WORLD 


GEORGE W. E. ATKINS, Vice-PRESIDENT NEWCOMB CARLTON, Presinewt BELVIDERE BROOKE, Vice-Presipent 


MONEY TRANSFERRED BY TELEGRAPH 


NOTICE TO PAYEE OF MONEY TRANSFER 


A telegraphic order to pay you a sum of money has just been received and we shall be glad to 
MBkenie pa yinent isvou willcallat.therofice NO... 
If not paid within 72 hours (exclusive of Sundays and Holidays), the order will necessarily be 
canceled and the amount’ thereof returned to the sender. 


Satisfactory evidence of identity will be required. 


MONEY TRANSFER AGENT 


BRING THIS NOTICE WITH YOU 





FIGURE 5 
Notice to payee of telegraphic transfer 


office to identify himself positively or to the satisfaction of the com- 
pany’s official, depending upon whether or not the sender has de- 
manded positive identification, and to receive the sum remitted. 

It is frequently necessary for banks to forward sums of money to 


30 DOMESTIC AND FOREIGN EXCHANGE 


their correspondents without loss of time. They also send telegraphic 
orders for their patrons. Let us say that Jones of San Francisco wants 
to telegraph $1000 to 
me Smith in Boston. He 
The Anglo& London ParisNational Bank | °° *° HS mee 


of Sea Francheco makes his request. The 
bank clerk hands him 
an application blank 
(Fig. 6), or the clerk 
cteesseeecnseessmenenemenerettnnemanccnncermeneresveregeemeeesssesfesanaemnamaantregenesceestssescenanta ae may write out the ap- 
plication for the cus- 
tomer as the latter dic- 
peda Beet aan beater sve na ene [Lda 5 tates the required data. 
Wor Aes't of: iscuutee oes ian oe _._ | The clerk gives the cus- 
tomer a receipt (Fig. 7), 
and also keeps a record 
Amount - - $. of the transaction for 
the bank’s files. The 
bank may, if it desires 
Telegram - - to do so, send the trans- 
fer through the tele- 
graph company, which 
will take care of it in 
the manner described 
Purchased by. | above, Asa rule, how- 
ever, the transfer will 
not be made in that 
J manner. Almost every 
Rive es bank has a copy of the 
telegraphic code of the 
American Banker’s As- 
sociation. The forwarding bank will usually send a message in 
code direct to a bank in Boston, with whom it may or may not 
have an ac ount, requesting it to pay $1000 to Smith. [If it has 
an account with the Boston bank, the code message will order 
that the account be debited to the extent of $1000. If it doesn’t 
have an account with the Boston bank, the message will state that 
remittance to cover is being forwarded by wire or by mail. In the 
latter case the Boston bank will lose interest on $1000 for a few days, 


TELEGRAPHIC TRANSFER 
To be placed to the Order of 


PA CLAP CSS eee ee ee reece oe ne eee 


Pemrencemnnncenensvecoes eweeseernetes sors scsesscretessanserrtcs costs eee eeenannnes ons pene cess scmmnenenemees owe ramen a= na name nnn. 


Premium 


Total - - 


Sari) FYRanCiSt0 gicqnccese es eee ee | OD mee 


NOie oe ee 





Application for bank telegraphic transfer 


DOMESTIC EXCHANGE 31 


The Anglo & London Paris National Bank 


No. B 15159 ae ee ae nti De a le SN fF 
om Vanes Tercerred Nec ee emer ck ee AA Es gt ge 
| we agree to place at the office. of 
totthe credit of 
DOLLARS, 


NOT RESPONSIBLE FOR ANY INACCURACIES OR DELAYS IN THE TRANSMISSION BY THE TELEGRAPH COMPANIES 


Amount : - —_—_—_—_—_—_——- THE ANGLO & LONDON PARIS NATIONAL BANK 
Exchange - 


Telegram - 


nay 
— 
we 
DH. 
a 
be 
1) 
_ 
= 
=. 
4 
oh 
— 
o 
Ge 
cae 
2 
aw 
a 
ES 
=) 
D 
[aa 


Cashier 





FIGURE 7 
Bank’s receipt for telegraphic transfer 


but such courtesies are usually granted by domestic banks to each other. 
The San Francisco bank will also mail an advice to the Boston bank 
notifying it of the details of the transaction. This is merely for con- 
firmation and for the purpose of checking up on the transaction to 
see that it goes through satisfactorily. The Boston bank will in its 
turn forward an advice to the San Francisco bank informing the latter 
that it has followed the telegraphic instructions and has paid the sum 
of money to the party designated. 

The charges for telegraphic transfers between banks vary with 
circumstances. In addition to the principal sum sent and the regular 
tolls of the telegraph company, the charges will include an “exchange ”’ 
charge varying with conditions. If the sum sent is large, the rate per 
hundred dollars will be less than if it is small. Some banks charge 
$.50 per $100, others $.75. For large amounts it is not unusual for a 
bank to charge as low as $.04 a hundred. If the bank is “long ” on 
funds in the payee’s city and wants to transfer some of its money 
to its own vaults at home, it will sell telegraphic exchange, as well as 
other kinds of exchange, at lower rates than if the reverse condition 
existed. By selling exchange, it gets cash in hand, and loses that 
amount from its balance with the bank upon which the exchange 
has been sold. Suppose that a bank in Denver is running short of 
funds in its own vaults, or suppose that it has a chance to invest its 
money at home and receive a larger return upon it than it is receiving 
on its balance deposited with the Old Colonial Bank of New York. 
It will telephone to other local banks asking them if they are in the 


32 DOMESTIC AND FOREIGN EXCHANGE 


market for telegraphic exchange on New York, and may find several 
which are short of funds in New York, but long on funds at home. 
To these, it will sell the necessary amount of telegraphic exchange, 
for cash. Then it has only to send a telegram to the Old Colonial Bank 
in New York, advising it to turn over to the New York banks des- 
ignated by the buying Denver banks, the sums of money represented 
by the amounts of exchange sold. The Old Colonial of New York 
debits the account of the selling bank, and pays the sums requested 
to the designated New York banks for the account of the buying 
Denver banks. 

The rates for telegraphic transfers are always higher than rates 
for other kinds of domestic exchange. If the customer sends a sight 
draft, the bank has the use of the money until its account with the 
bank upon which the draft has been drawn has been debited with 
the amount of the draft. But in the case of a telegraphic transfer, it 
takes only a few moments for the telegram to reach its destination, so 
that the bank gets practically no use of the customer’s money, and 
consequently has to charge a higher rate for such kind of exchange. 

With the introduction and extension of the Federal Reserve System, 
the activities of local banks in handling telegraphic transfers for large 
amounts have been greatly modified, in fact revolutionized. The 
change has come about through the use of the Gold Settlement Fund 
of the Reserve System for telegraphic transfer purposes. The Fund 
was established at Washington in May, 1915, by the Federal Reserve 
Board, and is operated directly under its supervision and by its 
appointees. Each Federal Reserve bank was required to deposit 
$1,000,000 gold or gold certificates with the Fund, to be used for the 
purpose of clearing obligations and items of one Federal Reserve 
bank upon another, thus making it unnecessary to ship gold, exchange, 
or money back and forth across the continent in the settlement of 
balances between the Federal Reserve banks. The Fund has increased 
rapidly since its establishment and on January 19, 1922, held a bal- 
ance of $468,174,000 for the twelve Federal Reserve banks and their 
branches.’ The regulations governing the operation of the Fund have 
been changed from time to time. At present clearings are made daily 
between Federal Reserve banks and sixteen out of their twenty-three 
branches by messages that are sent over their own leased wires. 


1Tt is held by the Treasurer of the United States. It also constitutes part of the gold 
reserves of the Federal Reserve banks. 


DOMESTIC EXCHANGE 33 


Every evening the Federal Reserve banks and their branches wire 
to the Fund stating the amounts due them from the other Federal 
Reserve banks and their branches. A settlement of obligations is 
effected merely by book entries, usually within an hour’s time after 
the receipt of the information, and a telegram is then sent each Federal 
Reserve bank or branch advising it as to the extent of its favorable 
or unfavorable balance as a result of the day’s clearings, and the 
balance which it has in the Fund. 

The Federal Reserve Board early saw the possibility of using the 
Fund in connection with the telegraphing of money from one section 
of the country to another and introduced a system of telegraphic 
transfers. As a consequence the whole field of domestic exchange, as 
it formerly existed, has been revolutionized, especially in connection 
with the transference of large sums of money, even for banks that 
are not members of the Federal Reserve System. The plan that was 
adopted is based primarily upon the Giro Conto Transfer System of 
the Imperial Bank (Reichsbank) of Germany. The Reichsbank has 
branches in practically every important city in Germany. If a mer- 
chant having a deposit with the Hamburg branch of the Reichsbank 
wishes to pay a firm in Berlin, he merely requests the branch to debit 
his account for a certain sum and to transfer that amount to the credit 
of the Berlin firm on the books of the Berlin branch. This the bank 
does by mail free of charge, but if done by telegraph a small fee is 
charged. Transfers under the Federal Reserve System are made by 
telegraph only and are sent free of charge but only at the request of 
banks that are either “member” banks or “non-member clearing”’ 
banks. Member banks are those that are stockholders in the Federal 
Reserve bank of their district to whom all privileges of the Federal 
Reserve System are accorded. ‘Non-member clearing” banks are 
those that are not stockholders, but that maintain a balance with the 
Federal Reserve bank of their district so as to enjoy some of the ad- 
vantages of the Federal Reserve System. They are allowed to have 
such privileges as sharing in the par-collection of checks," the collection 
of non-cash items, the use of the telegraphic transfer system, etc. 
Then there are also those banks that are not members of the Federal 
Reserve System and that do not keep any balance with the Federal 
Reserve bank of their district, but which nevertheless agree to remit 
at par for checks on themselves forwarded to them by a Federal Re- 


1 Cf. pp. 39-44. 


34 DOMESTIC AND FOREIGN EXCHANGE 


serve bank. Finally there are those non-member banks that are not 
even on the par-list. Only the first two groups of banks are allowed 
to share directly in the use of the Federal Reserve telegraphic transfer 
system, although indirectly, as we shall see, the others may use it by 
having a bank in either of the first two groups act for them. Inas- 
much as the Federal Reserve banks hold only the accounts of banks, 
the transfers must be made by and through banks and not by or 
through individuals. 

Today, if the San Francisco National Bank, a member of the Federal 
Reserve System, wishes to telegraph $1,000,000 to the National City 
Bank of New York, it may merely notify the Federal Reserve Bank 
of San Francisco to send the necessary wire. The Federal Reserve 
Bank of San Francisco deducts $1,000,000 from the account which 
the San Francisco National Bank has with it, making no charge for 
the service which it performs for the latter. It then sends a code 
message to the Federal Reserve Bank of New York, notifying that 
bank to pay $1,000,000 to the National City Bank for the credit of 
the San Francisco National Bank. The National City Bank, being 
a member of the Federal Reserve System, will have an account with 
the Federal Reserve Bank of New York and the latter pays the sum 
as requested by merely crediting the account of the National City 
Bank with that amount, and notifying the National City Bank that 
it has done so at the request of the San Francisco National Bank. 
The San Francisco National Bank thus has its account at the Federal 
Reserve Bank of San Francisco debited $1,000,000, while its account 
with the National City Bank is credited with a like sum. The claim 
of the Federal Reserve Bank of New York for $1,000,000 against the 
Federal Reserve Bank of San Francisco will b_ settled through the 
Gold Settlement Fund. Possibly on that same day, banks in the New 
York Federal Reserve district may telegraph $3,000,000 to banks in the 
San Francisco Federal Reserve district through the agency of the Fed- 
eral Reserve banks, while the latter may forward $5,345,000 to the 
former in the same manner. The balance for the day is settled by wire 
through the agency of the Gold Settlement Fund at Washington in the 
manner already described. 

Not only do the Federal Reserve banks supply telegraphic ex- 
change for “member” banks and for “non-member clearing” banks, 
but they also afford the same service indirectly to the customers of 
those banks. If Stephens in Sacramento, California, desires to send 


DOMESTIC EXCHANGE 35 


$5,000 to Reilly and Company in New York, whose bank is the Na- 
tional Bank of Commerce, he merely pays his local bank, if a member 
or a non-member clearing bank in the Federal Reserve System, 
$5,000 and requests it to make the transfer for him. The local 
bank then advises the Federal Reserve Bank of San Francisco, 
by wire, to debit its (the Sacramento bank’s) account with $5,000 
and to transfer that sum of money by telegraphic order to Reilly 
and Company through the National Bank of Commerce in New 
York. The Federal Reserve Bank of San Francisco wires the Fed- 
eral Reserve Bank of New York to pay the sum to Reilly and 
Company through the National Bank of Commerce. The latter bank 
will be credited on the books of the Federal Reserve Bank of New 
York with the $5,000, and may receive that sum in actual funds or 
let it stand to its account. The National Bank of Commerce credits 
Reilly and Company with $5,000, and the latter likewise may either 
cash against that sum, or let it stand to their credit on the books of 
the National Bank of Commerce. If the banks make no charge to 
correspondents or customers, the Federal Reserve banks make no 
charge for the service rendered. 

Another interesting angle of the situation is the possibility of a 
bank that is not a member of the Federal Reserve System, or a “non- 
member clearing ” bank, or a customer of such a bank, securing this 
same service free of charge. This may be accomplished in the follow- 
ing manner: Let us say that the Emporium Department Store of 
San Francisco has an account with the Union Trust Company of that 
city. The latter is not a member of the Federal Reserve System, but 
has as its local agent, or is financially connected with, the Wells Fargo 
Nevada National Bank, which is a member of the Federal Reserve 
System. If the Emporium wishes to send $500,000 to Reilly and Com- 
pany in New York and asks the Union Trust Company to do so for 
it, the Union Trust Company will request the Wells Fargo Nevada 
National Bank to put through the transaction just as though the 
Emporium were a customer of the Wells Fargo Nevada National 
Bank. The Emporium pays the Union Trust Company $500,000, 
by check or cash. The Union Trust Company may send cash, a check, 
' or a draft for $500,000 to the Wells Fargo Nevada National Bank, 
either directly or through the clearing house. The Wells Fargo Nevada 
National Bank then requests the Federal Reserve Bank of San 
Francisco to forward $500,000 telegraphic exchange to the National, 


36 DOMESTIC AND FOREIGN EXCHANGE 


Bank of Commerce for the account of Reilly and Company. This 
would be done, as in the above example, through the Federal Reserve 
Bank of New York. 

It is also possible for a member bank to telegraph funds to a non- 
member bank by means of this system. Let us say that the Wells 
Fargo Nevada National Bank of San Francisco wishes to remit $10,000 
to the Milwaukee State Bank. It requests the Federal Reserve Bank 
of San Francisco to send the telegraphic transfer. The latter wires 
the Federal Reserve Bank in Chicago, which in turn notifies a member 
bank in Milwaukee, let us say, the First National Bank of Milwaukee, 
that $10,000 has been credited to it for the account of the Milwaukee 
State Bank. The First National Bank then turns over $10,000 to the 
Milwaukee State Bank. It should be noted, however, that the Federal 
Reserve banks will forward telegraphic transfers directly for member 
and “non-member clearing”? banks acting either for themselves or 
for their customers, when the transfers are to be sent to or through 
member or “non-member clearing” banks. Banks that are neither 
members of the Federal Reserve System nor “non-member clearing” 
banks cannot transmit funds directly through the Federal Reserve 
banks, nor will any Federal Reserve bank accept transfers to be sent 
directly to them. They may, however, as we have seen, send trans- 
fers through member or “non-member clearing” banks, and on 
the other hand transfers may be sent to them only through such 
banks. 

Thus far the Federal Reserve Board has left to the individual 
Federal Reserve bank the decision as to the minimum sum that will 
be transferred in the manner above described. One Federal Reserve 
bank has fixed the minimum amount for customers’ telegraphic trans- 
fers at $1,000, another at $2,500. This rather high limit was decided 
upon in order to prevent the already crowded telegraph wires of the 
Federal Reserve System being swamped with an unlimited number 
of small $100 or $200 transfers for customers of member and “non- 
member clearing” banks. The Federal Reserve bank that has the 
$2,500 limit for customers’ transfer, however, permits member and 
“non-member clearing” banks to send transfers for themselves, not 
for customers, for as low an amount as $1,000. 

Some banks make use of the telegraphic transfer system of the 
Federal Reserve banks for the purpose of earning a day’s interest on 
funds thus transferred. This is done as follows: Let us say that the 


DOMESTIC EXCHANGE 37 


Fourth National Bank of San Francisco has payments of $1,000,000 
to make to various firms in New York, either for its own account or 
for the accounts of its customers. It instructs the Federal Reserve 
Bank of San Francisco to wire that amount to the Chase National 
Bank of New York. The Federal Reserve Bank of San Francisco 
does so. At the same time the Fourth National Bank wires the Chase 
National Bank that a telegraphic transfer is being sent it through 
the Federal Reserve banks of San Francisco and New York, and that 
the sum is to be paid out in designated amounts to different parties. 
When the Federal Reserve Bank of New York notifies the Chase 
National that the latter has been credited with $1,000,000, it is, to the 
Chase National Bank, the equivalent of having $1,000,000 in its own 
vaults. It therefore proceeds to draw checks on itself (cashier’s checks) 
and mails them to the parties designated by the Fourth National 
Bank of San Francisco. Or if the sums are to be paid to banks which 
are members of the Clearing House of New York, the checks will be 
sent to them that day through the Clearing House. The checks that 
are sent out by mail will be received by the customers possibly on that 
same day, but will be presented to the Chase National through the 
Clearing House the next day. Consequently the Chase National 
Bank will have the use of the $1,000,000 for a day. The ac- 
count of the Fourth National Bank of San Francisco with the 
Chase National Bank will be credited with that sum and will 
receive a day’s interest thereon (usually at the rate of about 2 per 
cent). 

A bank sending a telegraphic transfer through the Federal Reserve 
banks to another bank usually itself wires the “advice” as to the 
amount, for whose account, etc., or it may send such an advice by 
mail. This is done for the purpose of confirmation, and to avoid any 
possible mistake or error. 

Telegraphing money is safe, quick, and a very simple and effective 
method of transferring funds or making payments between distant 
communities. It is being more and more widely used by all classes 
of people and by financial institutions. In 1915 the Western Union 
forwarded $30,000,000 in this manner. No data are available as to 
the extent that banks employ telegraphic transfers either by means 
of the service afforded by the Federal Reserve banks or by the tele- 
graph companies themselves.’ 


1Some idea of the extent of the total amount of telegraphic transfers sent in 1920 by 


35 DOMESTIC AND FOREIGN EXCHANGE 


Checks. A person owing a sum of money to another in a distant 
city usually forwards his personal check for the amount. A chéck 
(Fig. 8) is an order upon a bank by a depositor requesting the bank 
to pay a certain sum of money on demand to the depositor himself, 
to the bank itself, or to a third party who is sometimes designated as 
the “bearer.”’ Most frequently the check is made out to a third 
party “or order.” The recipient of a check either deposits it at his 
own bank and receives actual cash or an addition to his deposit ac- 
count, or he indorses it and passes it to another person who in his turn 
cashes it, or indorses it and passes it on to another. Ultimately, it is 





FIGURE 8 
Bank check 


presented to the bank upon which it has been drawn, is paid, the sum 
deducted from the account of the drawer, and the check cancelled 
and returned to the drawer. 

The party who draws the check seldom appreciates or knows any- 
thing about the complicated machinery of banking relations that lies 
behind its collection. Until 1915 there was no system of national 
extent nor was there a central directing force or scheme to be found 
in connection with the collection of checks. A check might wander 


the Federal Reserve banks may be gained from the following data covering only five of 
those institutions: 


Items Amount 
New V Ork2 Aste eae 147,302 $17,021,500,734 
Philadelphiae2 cesneee oe eo 9,832 625,338,000 
Richmowd (At) Se wack es 21,836 1,246,861,158 
SCiLows uy oie ee oe 32,008 1,225,250,058 


San Kran ciscos/ auch wins 29,291 3,043,193,000 


DOMESTIC EXCHANGE 39 


over the greater part of the United States before reaching the bank 
upon which it had been drawn. Jones in Chicago, for instance, might 
draw a check on the Commercial National Bank of that city and for- 
ward it to Smith in Los Angeles. Smith would cash it at his bank, but 
not at its face value. The bank would make what was called an “ex- 
change charge,” varying from five cents to twenty-five cents, for its 
services in connection with the collection of the check. The Los 
Angeles bank might then send the check to the New Orleans State 
Bank for the purpose either of building up its account with that bank 
or of settling some obligation which it owed that bank. The New 
Orleans bank might then forward the check to the Liberty Trust 
Company of New York for similar reasons. The Liberty Trust Com- 
pany might send it to the Plymouth National Bank of Boston, which 
in its turn might forward it to a bank in Minneapolis, and so on, the 
check passing through a number of other banks until it would be re- 
turned finally to the Chicago Commercial National Bank. The check 
might be out on the road, in “float” as it is called, for several weeks. 
It might crisscross back and forth across its own path several times. 
Each bank would make an exchange charge for the costs of book- 
keeping, handling, mailing, etc. Any day ten banks in a city might 
have a large number of items on the same banks in other cities and 
send them out along any number of separate paths for collection. 
Merchants were harassed by the collection charges imposed by banks 
for the cashing of these so-called “country” or out-of-town checks, 
losing from five to twenty-five cents on the face value of each check. 
Outside of the establishment of a few “country” or “regional clear- 
ing houses” for the more economical and efficient collection of such 
items, nothing had been done up to 1915 to remedy the situation. 
These regional clearing houses, which had been established at Boston, 
Kansas City, and a small number of other cities, had reduced the time 
of collection about 25 per cent and had saved their members about 
50 per cent in the expense of handling such checks. But most banks 
were not willing to join in the organization of regional clearing houses, 
and as a consequence the antiquated system of collecting checks, in 
spite of its deficiencies and shortcomings, remained practically un- 
changed until 1915. 

When the Federal Reserve law was passed in 1913 it contained a 
provision (Section 16) to the effect that the Federal Reserve banks, 
if directed by the Federal Reserve Board, were to act as clearing houses 


40 DOMESTIC AND FOREIGN EXCHANGE 


for the collection of checks for their members, while the Federal Re- 
serve Board itself was authorized to act as a clearing house for the 
Federal Reserve banks or to require one of the Federal Reserve banks 
to act for it in that capacity. The Federal Reserve Board considered 
this to be one of the most important responsibilities with which it was 
charged under the Act and early began to prepare a series of regulations 
designed to carry out the provisions of the law. First of all, in May, 
1915, it established the “Gold Settlement Fund” as above described. 
Next, in order to educate the bankers of the country to appreciate the 
advantages of the par collection of country checks, the Federal Re- 
serve Board in 1915 authorized the Federal Reserve banks to establish 
a voluntary check collection system. The scheme did not work out 
satisfactorily, chiefly because it was a voluntary system and few banks 
joined in it, so on July 15, 1916, the Federal Reserve Board inaugurated 
a compulsory par collection system. The essence of the plan was that 
all member banks should pay the checks drawn on them, when pre- 
sented by a Federal Reserve bank, without deducting any exchange 
charge, i. e., they were to remit the full face value of the check to the 
Federal Reserve bank which presented the check for payment. Mem- 
ber banks were still allowed to send checks through the old channels 
if they desired, and to make such charges as they wished, but not to 
exceed ten cents on the $100; but if checks were sent through the 
Federal Reserve banks for collection, no such deductions could be 
made. To make the system effective it was necessary to induce or 
compel the non-member banks to enter the check collection system 
either as “non-member clearing”’ banks or as banks that would agree 
to remit at par. As we have seen in the last section, they did not have 
to become stockholding members of the Federal Reserve System to be 
a part of the par collection system. As “non-member clearing” 
banks they kept funds or balances with the Federal Reserve bank of 
their district, while as “par list” banks they agreed only to remit at 
par, i. e., to make no exchange charge, for all checks presented to them 
for payment through the mails or otherwise by the Federal Reserve 
bank of their district. 

Great opposition was shown by many of the member banks, and 
especially by the non-member state banks. However, when a member 
bank in a city, compelled as it was by the rules of the Federal Reserve 
Board, remitted for its checks at par, other banks who were non-mem- 


1 Cf. pp. 32-33. 


DOMESTIC EXCHANGE 41 


bers immediately found their checks at a disadvantage in the local 
market. Also, again and again, when a non-member bank refused 
to remit at par, the Federal Reserve bank presented the check to the 
bank through an express company or some other agency and com- 
pelled it to pay the same at par over its counter, even though the 
costs to the Federal Reserve bank in pursuing this method of collection 
were at times greatly in excess of the small collection or exchange 
charge that would have been made by the non-member bank. The 
par collection system spread rapidly, however, and on January 1, 1922, 
included all but about 2,o00 banks in the United States.1_ The magni- 
tude of the operations of the Federal Reserve banks in this connection 
is shown by the fact that, in 1921, 522,665,000 items, totalling $118,- 
844,391,000, were collected through this agency. 

Charges varying from 1 to 114¢ per item, imposed by the Federal 
Reserve banks during the first few years, were abolished in 1918, and 
all checks and drafts are now collected free of charge when passed 
through the par collection system. In June, 1920, the Federal Re- 
serve banks also established a collection department for the collection 
of maturing notes, bills, and other collection items. Credit is given 
only when these items have actually been paid. The Federal Reserve 
banks impose no charge for the collection of the latter group of items 
except to cover any “collection charges made by the collecting bank 
and for registration, insurance or express charges on negotiable se- 
curities (coupons, etc.) payable out of the Federal Reserve city.” ” 

The Federal Reserve banks and their branches have in this way 
become a great collecting agency for the systematic and efficient 
handling of the collection of checks, drafts, and other similar items. 
By means of the arrangements provided it is possible for banks to 
build up their accounts with the Federal Reserve bank of their dis- 
trict, to shift funds about the country as desired, to collect moneys 
owing them in a minimum of time, to say nothing of the various other 
services provided, and all this is performed free of charge, except in 
the case of the collection of maturing notes, bills, and similar collection 
items, which is done at cost. 

The par collection system gives immediate credit to the depositing 
bank on all items deposited, but the proceeds do not become available 
for the use of the depositing bank until actually collected or until a 


1 There were about 31,000 banks in the United States on that date. 
2 Circular ror, Federal Reserve Bank of San Francisco. 


42 DOMESTIC AND FOREIGN EXCHANGE 


certain number of days have elapsed if perchance the item has not 
actually been collected by that time. Each Federal Reserve bank or 
branch has an “Availability Schedule” which fixes the number of 


AVAILABILITY SCHEDULE FOR DEPOSIT OF CHECKS AND DRAFTS WITH 
SEATTLE BRANCH, FEDERAL RESERVE BANK OF SAN FRANCISCO 


For Availability Schedule of Items ‘‘Direct Routed’’ to other officea of this bank, see their respective schedules, 





SUBJECT TO DEPOSITED IN SEATTLE ON: 























pepeapela 12TH DISTRICT omnes 
Seattle 
Immediata United States Treasury Warrants 
Drafts on Federal Reserve Bank of San Francisco—Head Office and 
Branches 
1 Day....] Portland, Spokane 
2 Days...§ Washington—Seattle Zone, excepting places noted in 3-day division 
Salt Lake City, San Francisco 
Washington—Seattle Zone, the following places: 
Days... Black Diamond Raymond South Bend Wilkeson 
Langley Snoqualmie Toledo 
Los Angeles Peet 
Oregon—Country Kansas City 
4 Days.--] Washington—Portland Zone Minneapolis 
Washington—Spokane Zone Omaha 
_ St. Louis 
Atlanta Cleveland Little Rock Memphis | 
Baltimore Cincinnati Louisville Philadelphia 
5 Days...] Idaho Birmingham Dallas Nashville Pittsburgh ' 
Boston Detroit New York City Richmond 
Buffalo El Paso New Orleans 
California—Country Houston Illinois Michigan Missouri 
6 Days...{ Nevada Jacksonville Indiana Minnesota Wisconsin 
Utah—Country lowa 
Arkansas Maryland New Mexico— Rhode Island 
Colorado Massachusetts 10th District South Dakota 
; Connecticut Montana N.Y. State Tennessee 
7 Days.. Arizona—12th District Delaware Nebraska North Dakota Vermont 
} Kansas New Hamp- Ohio Virginia 
Kentucky shire Oklahoma Wyoming 
Maine New Jersey Pennsylvania 
Alabama Georgia New Mexico— _ S. Carolina. 
8 Days... Arizona— Louisiana 11th District Texas. 
11th District Mississippi N. Carolina West Virginia. 
FIGURE 9 


Availability schedule for Seattle branch Federal Reserve Bank of 
San Francisco 


days that must elapse before the items deposited are available for 
use by the depositing bank. The following schedule (Fig. 9) of the 
Seattle branch of the Federal Reserve Bank of San Francisco is typical 
of lists issued by Federal Reserve banks and their branches. 


DOMESTIC EXCHANGE 43 


If, for instance, the Tacoma National Bank deposits with the Seattle 
branch a check for $500 on a Los Angeles bank, the funds that the 
check represents become available for the use of the depositing bank 
on the fourth day, no matter whether or not the check has actually 
been paid by the Los Angeles bank. If the check is on the First Na- 
tional Bank of Jacksonville, Florida, the funds become available 
after nine days have elapsed. In the case of the Florida check, the 
method of procedure would be somewhat as follows: The check would 
be deposited with the Seattle branch of the Federal Reserve Bank of 
San Francisco, which would enter on the account of the Tacoma Na- 
tional Bank a deferred credit of $500 to become available nine days 
hence. The Seattle branch would then send the check to the Federal 
Reserve Bank of Atlanta, which would credit it with that sum. The 
Atlanta institution would then forward the check to the Jacksonville 
bank. The Jacksonville bank would remit $500 in gold or paper 
money other than National Bank notes to the Federal Reserve Bank 
of Atlanta, the costs of the shipment being borne by the Federal Re- 
serve Bank of Atlanta. The Federal Reserve Bank of San Francisco, 
being the head office of the Seattle branch, would have $500 coming 
to it from the Atlanta Reserve Bank and its claim would be cleared 
through the agency of the Gold Settlement Fund without the necessity 
of shipping any exchange, gold, or money from Atlanta to San Fran- 
cisco. Ail branches of a Federal Reserve bank transact their business 
in the name of the head office. 

If, in order to save time, banks in the clearing system desire to send 
their items for collection direct to a Federal Reserve bank or its branch 
located outside of the district in which the banks are located they 
may be authorized to do so and may receive credit at the office of the 
Federal Reserve bank with which they are affiliated, but ordinarily 
they will clear checks and other items directly through the Federal 
Reserve bank of their district. 

The par collection system, therefore, has made the check a much 
more useful means of payment than ever before. It has saved time, 
labor, and much expense. Each bank now sorts its items according 
to banks and cities and reserve districts. These bundles of checks flow 
into the Federal Reserve bank of the district, which gathers all the 
checks on one bank into one package, and all the checks on banks in 
one district into a still larger package. The checks that are to be 
cleared through the Federal Reserve Bank of Chicago go to that 


44 DOMESTIC AND FOREIGN EXCHANGE 


institution; those that are to be cleared through the Federal Re- 
serve Bank of New York go there—the idea being to collect items: 
directly and with the least expenditure of time, expense, and energy. 
As noted above, the balancing of credits and debits between the 
various Federal Reserve banks that arise in this and in other 
connections is made through the Gold Settlement Fund at Wash- 
ington. 

The results of the clearings and collections obtained thus far through 
the activities of the Fund have been truly surprising, while the costs 
have been extremely slight. Combined clearings and transfers through 
the Fund during the year 1921 aggregated $68,223,882,000 as com- 
pared with $92,625,805,000 for 1920, $73,984,252,000 for 1919, $50,- 
251,592,000 in 1918, $27,154,704,000 in 1917, $5,533,966,000 in 1916, 
and $1,052,649,000 in 1915, making a grand total of $318,826,850,000 
since the inception of the Fund on May 20, 1915. “When it is con- 
sidered that these enormous transfers are made almost instantly by 
means of the leased wire system without involving the physical move- 
ment of a dollar, it will be seen that that arrangement has been of 
incalculable value to the Government, the banks and the public.” * 
The total expense of operations for 1921, including the entire cost of 
the leased wires and salaries of accountants, was approximately 
$485,000. This represents the basic cost of effecting domestic ex- 
changes between the several Federal Reserve districts. A charge of 
ro cents per $100, if generally imposed, would have involved an ex- 
pense to the Treasury and the commerce of the country of $68,223,000 
for the transfers made during 1921. 

The large sums representing the combined transfers and clearings 
effected through the Gold Settlement Fund, averaging about $1,500,- 
000,000 weekly, have been due to the heavy movements of funds by 
the Government (the Federal Reserve banks now being authorized 
to act as the fiscal agents of the Government because the sub- 
treasuries have been abolished), and to large transfers for the ac- 
counts of member banks in connection with telegraphic exchange, 
the collection of country checks, and other items. 

Bank Drafts. The existence of the Gold Settlement Fund also 
makes it possible for the Federal Reserve banks greatly to simplify 
the means by which member banks in any part of the country may 
provide themselves with “New York exchange,” to be availed of by 

1 Annual Report of the Federal Reserve Board, 1920, p. 71. 


DOMESTIC EXCHANGE 45 


drafts on their accounts with New York banks whenever desired 
either for their own needs or for those of their local customers. 

Bank drafts on New York still bulk very large in domestic exchange 
transactions, although they are by no means so important as before 
the introduction of the Federal Reserve System of telegraphic trans- 
fers and the par collection of checks. They are still used for small 
sums up to $1,000 or more by customers of member banks and of 
course for even larger sums by customers of non-member banks unless 
the latter have an arrangement with a member bank or a non-member 
clearing bank whereby telegraphic transfers may be procured through 
a Federal Reserve bank. 

It is not strange that New York exchange should still be the most 
important kind of domestic exchange remitted by mail. New York is 
the financial center of the United States. Banks all over the country 
have either direct or indirect connection with financial institutions 
in that city. There is also some Chicago, St. Louis, and San Francisco 
domestic exchange (bank drafts on those centers) demanded by 
customers, but the great bulk of bank draft exchange is on New York. 
If a man in Seattle wishes to pay a bill in Chicago, his bank will sell 
him a draft on its account with a New York bank. If aman in Denver 
wishes to pay a bill in Mobile, or Los Angeles, or Boston, it is more 
than likely that his local bank will provide him with a draft on its 
account with a New York bank. The reason for this is simply that 
all banks have a continual demand for exchange of some sort or other 
on New York. They must build up their accounts in that city with 
which to meet this demand. When a customer deposits a draft on a 
New York bank, the local bank sends it on to be collected and credited 
to its New York account. The demand for New York exchange in 
connection with domestic financial affairs is as widespread as is the 
demand for exchange on London in the field of international financial 
operations. 

If Baker in San Francisco has purchased $1,000 worth of goods 
from Foster in Boston, he goes to his local bank, say, the First Na- 
tional Bank, and asks it for a bank draft for that sum on its New York 
correspondent, say, the Chase National Bank. The San Francisco 
bank builds up its account by sending various items to the Chase 
National Bank for collection. These items may be on New York firms 
or banks, or on firms or banks located elsewhere in the East. The 
First National Bank is a member of the Federal Reserve System, and 


46 DOMESTIC AND FOREIGN EXCHANGE 


may also at any time replenish its account by having the Federal Re- 
serve Bank of San Francisco telegraph the needed funds to its corre- 
spondent in New York in the manner described above.! 

As will be noted from the accompanying bank draft (Fig. 10), the 
name of the remitter does not appear on its face. A bank draft is 
merely an order from one bank to another requesting the latter to pay 
a certain sum to a third party and to debit or charge the account of 
the drawing bank which is on deposit with the paying bank. If the 
drawing bank does not have sufficient funds on deposit with the pay- 
ing bank at the time when it draws the draft, it is necessary for it to 


yo. 387 
AN ee S00» I-8 


arch 5 aoe 






Si 900-00 
c. = sone Chousend and 00/10 me ts 


_ | CHASE NATIONAL BANK 


NEW YORK CASHIER 





FIGURE 10 
Bank draft 


provide such funds by remitting telegraphic or other exchange to meet 
the payment of the draft when it is presented. 

The First National Bank will provide Baker with a draft on the 
Chase National Bank for $1,000. Whether it will charge him more 
than $1,000 for the draft, i. e., whether it will make an “exchange” | 
charge, depends upon certain circumstances which will be discussed 
later.” Baker mails the draft to Foster, his creditor, in New York. 
Foster deposits it to his account in his local bank, let us say, in the 
Irving National Bank. The Irving National Bank collects it from 
the Chase National Bank through the clearing house or by messenger. 
The Chase National Bank deducts the amount of the draft from the 
account of the First National Bank on deposit with it and sends an 
advice thereof to the latter. | 

In connection with the issuance of such drafts, several technical 


1 Cf. pp. 34-37. 2 Cf. p. 48. 


DOMESTIC EXCHANGE 47 


terms arise that must be kept clearly in mind throughout our subse- 
quent discussion, because we shall use them constantly. The party 
that draws the draft, in the above case the First National Bank, is 
known as the “drawer”; the party upon whom the draft is drawn, 
in this case the Chase National Bank, is known as the “drawee’’; 
the party to whom the draft is made payable, in this case Foster of 
New York, is the “payee”; the party that pays the draft, 1. e., the 
Chase National Bank, is the ‘‘payer.” 

The essential difference between a check and a bank draft is that 
the former is an order of an individual or firm, not a bank, to a bank 
ordering the latter to pay a certain sum of money to a third party from 
the account of the party that drew the check. A bank draft is an 
order drawn by a bank on another bank ordering the latter to pay a 
certain sum of money to a third party out of the account of the draw- 
ing bank. 

Sometimes banks make arrangements whereby they are permitted 
to draw directly upon a New York bank even though they have no 
account with the latter, the agreement being that the drawing bank 
shall remit immediately to cover the amount of the drafts issued. 

Up to the time of the inauguration of the telegraphic transfer 
system of the Federal Reserve banks, rates of domestic exchange, 
telegraphic and mail, were quoted as commonly as foreign exchange 
rates are quoted today. The following is typical of the weekly an- 
nouncements that formerly appeared in the Amnalist of New York: 


DomMEsTIC EXCHANGE RATES 


The week’s range of exchange on New York at Chicago last week 
was from 25c @ toc discount, closing at the former; at Boston it 
stood at par all week; at St. Louis it was 25c @ 15c discount, clos- 
ing at the former, and at San Francisco it was 30c premium all week. 


According to this announcement, Chicago banks apparently had 
a considerable supply of funds in New York which they were willing 
to dispose of by means of New York drafts at from $.10 to $.25 
discount on $1,000. In Boston the supply of exchange on New York 
about balanced the demand for such exchange, so that the Boston 
banks were willing to sell it at par, making no charge and taking no 
discount. In San Francisco, however, the demand for New York ex- 
change was heavy and the banks were having a hard time to get an 
adequate amount, so they were charging $.30 premium, i. e., a New 


48 DOMESTIC AND FOREIGN EXCHANGE 


York draft for $1,000 would cost $1,000.30. Frequently the rates 
would be published as “Domestic exchange [meaning on New York] 
2¢ premium regular, ’’! which would signify that a draft on New York 
would be charged at the rate of $.02 per $100. It was not unusual 
to charge a sliding rate which would decrease with larger amounts, 
e. g., 5¢ up to $25, 1o¢ for $25 to $100, 50¢ per $1,000, etc. 

The basic rates of domestic exchange used to vary from day to day, 
and would experience the same general tendencies in their swing up- 
ward or downward as foreign exchange rates, depending in general 
upon the same factors that influence foreign exchange ratés. In the 
late summer and fall of the year when the West was shipping the East 
a large amount of goods, countless drafts would be drawn on eastern 
consignees, thus creating a large supply of exchange and consequently 
tending to weaken exchange rates on New York and other eastern 
centers. In the spring and early summer the West would be buying 
more heavily from the East, and exchange rates would then tend to 
rise. As is true also in the field of foreign exchange,” the limits within 
which domestic rates on New York would fluctuate were determined 
by the cost of shipping gold. It cost normally about $.50 to ship 
$1,000 in gold from New York to Chicago, $.60 to St. Louis, $.75 to 
New Orleans, and $1.50 to San Francisco. If a banker in Chicago 
had to pay more than $1,000.50 for a $1,000 draft on New York, he 
preferred to ship gold instead of purchasing a bank draft because he 
could do so at a profit. Likewise if a shipper in Chicago had to accept 
less than $999.50 for his drafts on New York consignees, he preferred 
to send his bill to New York for collection and to have gold or currency 
sent him. If Chicago banks were forced to sell bank drafts on New 
York for less than $999.50, it would pay them to have gold shipped 
to them from New York. 

The old system and the old methods were revolutionized by the 
practices inaugurated by the Federal Reserve System. Today the 
applicant for New York drafts is usually not charged any exchange 
for the service that is accorded. But if he asks for too large an amount, 
or if he is a stranger at the bank, or if he asks daily for a large number 
of drafts on New York, the bank may make what it calls a “service 
charge,” usually rather small in amount. Domestic exchange rates no 


1 Drafts on New York banks were called “‘regular exchange”’ so as to differentiate them 
from ‘‘telegraphic exchange.”’ 
* Cf. Chapter XI, Gold and Gold Movements. 


DOMESTIC EXCHANGE 49 


longer fluctuate as they used to, nor do banks ship gold from one to 
another. Gold is transferred through the Federal Reserve banks 
without charge. If a San Francisco bank desires to pay $100,000 in 
gold to a New York bank, it may send the gold to the Federal Reserve 
Bank of San Francisco, charges collect. The latter then wires the 
Federal Reserve Bank of New York to pay out that sum in gold to the 
designated New York bank. No charges for this sort of service are 
made to member banks or to non-member clearing banks. 

It is not possible for all banks to keep accounts with correspondents 
in New York. Arrangements are therefore made with banks that 
do keep such accounts whereby banks without correspondents are 
authorized to draw drafts on New York by means of a system of 
“advices.” If the State Bank of Madison, Wisconsin, has made 
arrangements with the Chicago Commercial Bank to draw on the 
latter’s New York correspondent, say the Chase National Bank, it 
can sell a draft to its customer on the Chase National Bank, drawing 
the draft on blanks furnished by the Chicago bank. The drafts bear 
the monogram or mark of identification of the Chicago bank, so that 
the Chase National Bank knows through which one of its correspond- 
ents the draft has been drawn. An advice is sent by the Madison 
bank to the Chicago bank notifying it of the sale, to whom payable, 
the amount, date, etc. The latter then debits the account of the 
Madison bank and sends an advice to the Chase National Bank. 
When the draft reaches the Chase National Bank either over the 
counter or through the clearing house of New York, it is paid and the 
amount deducted from the account of the Chicago Commercial Bank. 

Traveler’s Check. All the forms of domestic exchange discussed in 
previous pages deal with a situation in which the debtor stays at home 
and forwards exchange with which to meet his obligations. But if 
he were traveling from place to place and desired to have available 
the wherewithal to pay bills as he goes, it would not be advisable for 
him to carry cash. To carry cash, either metal or paper, in large 
amounts is bothersome and extremely risky. As long ago as 1891 
the American Express Company devised a most satisfactory sub- 
stitute, viz., the “traveler’s cheque” or the “traveler’s check.” 
Other express companies followed the example of the American Ex- 
press Company, until with their amalgamation into the American 
Railway Express Company all express offices now issue only the 
American Express Company’s traveler’s checks. Somewhat later, 


50 DOMESTIC AND FOREIGN EXCHANGE 


the Bankers’ Trust Company of New York obtained permission from 
the American Bankers’ Association to issue what are known as the “A. 
B.A. Cheques” to any bank that desired them for the accommodation 
of its customers. Subsequently several other large banks in New York 
notified their correspondents that they too would issue traveler’s 
checks under conditions similar to those of the Bankers’ Trust Com- 
pany. At present traveler’s checks may be obtained from practically 
any bank and from all express company offices in the United States 
as well as from many hotels, stores, etc. 

Traveler’s checks may be issued in terms of dollars or in terms of 





FIGURE II 


Book of traveler’s checks 


both dollars and the more commonly demanded foreign moneys, 
such as sterling, francs, etc. Before 1914 the latter was the more 
customary form, and when foreign exchange rates again return to 
normal it will undoubtedly come back into general use. The World 
War, with its wide fluctuations in the exchange rates on foreign 
countries, brought into existence a form of traveler’s check payable 
in the United States and Canada in dollars and in foreign countries in 
terms of foreign money at the banker’s selling rate for sight drafts on 
New York. In the present section we shall confine ourselves to a 
description of the traveler’s check as employed in domestic travel. 

Say that the traveler goes to his bank or to the express company 
office and asks for a book of traveler’s checks (Fig. 11) amounting 


DOMESTIC EXCHANGE 51 


in all to $1,000. He may have them in various combinations of 
denominations, inasmuch as they are issued in denominations of $10, 
$20, $50, $100, and $200. The printed blanks are supplied the agent 
by the main office of the express company, the Bankers’ Trust Com- 
pany, or the issuing New York bank. The clerk fills out the blanks, 
each one of which has been numbered before being sent out by the 
issuing office. The clerk, or one of the officials of the bank, signs his 
name in the lower right-hand corner of the check. The purchaser 
signs his name in the upper left-hand corner. The clerk then collects 
$1,000 from the purchaser plus a commission of $.75 per $100 or 
$1,007.50 in all. The selling bank or hotel retains two-thirds of the 
commission ($5.00) and remits the principal ($1,000) plus the remain- 
ing one-third of the commission ($2.50) to the issuing company. 
The purchaser takes his book of checks and departs.. When he wishes 
to cash one of the checks, he presents it at a hotel, bank, express 
company, or store, and usually has no difficulty in cashing it. To make 
the check negotiable, he merely signs his name in the lower left-hand 
corner of the check. The party cashing the check compares the signa- 
ture at the top of the check with the one at the bottom and if they 
are the same, the money is paid to the traveler. This method of 
identification obtains the world over. 

A.B.A. traveler’s checks are sold only by banks, but the American 
Express Company traveler’s checks may be purchased at hotels, stores, 
express offices, banks, etc., under the same conditions and terms as 
hold in the case of the A.B.A. checks. The American Express Com- 
pany and the large New York banks that issue traveler’s checks give 
the selling agent the greater portion of the commission because they 
get the use of the principal until the checks are finally paid by them. 
In some extreme cases this has meant the use of the principal for ten 
or twenty years, but usually for several weeks or months.’ 

The advantages of traveler’s checks are many. They are issued in 
a neat.leather folder convenient to carry. They are easily cashed 
and do not require the identification necessary in case of personal 
checks or drafts. They are cashed for their face value, no discount 
being charged. If lost, the traveler gives due notice to the bank or 
express company upon which they have been drawn, and after he signs 


1 During the Yukon gold rush in the go’s a large number of the gold seekers took traveler’s 
checks with them. Many were cashed years afterwards, and some have not yet been 
cashed. 


52 DOMESTIC AND FOREIGN EXCHANGE 


certain protective forms, his money is refunded. Notices are then 
sent out cautioning all parties not to cash the lost or stolen traveler’s 
checks, which can be identified both by their number and by the 
signature of the traveler. They cannot be cashed unless properly 
countersigned, and few forgers are able to execute another person’s sig- 
nature in the presence of the cashing agent. It is not necessary to cash 
them at a bank. This is a decided advantage because banks are open 
only during certain hours of the day and only on banking days, while 
the traveler sometimes needs funds on a holiday or when in a small 
town which has no bank. 

Travelers’ or Circular Letters of Credit. Domestic travelers’ letters 
of credit, frequently known as “circular” letters of credit, are also 
used by those who ie but are more a aes employed wher« 


Ho by 1 foot a 


Ainge 
© se ae — 
5 A, aes ti 





S50, COO 


TheFirst National Bank of San francisco | 
hn CO om a LIL “f : 


t 


. Ghys Movies, 
| Wi, Li Ka Aoaiar de enbudsce ley thd. 
ae Wilhs UN >. Ae Vx Roa 
CHtabe egypt < fie 47h tbo Spee und ustcne ixcvoranthle fees ee th a. oo 
LG VIE x a btifts ee : s iil i 
| nla Bunhioren lhe balinal Banks ofl. Lommeciv dn boa henke 
fii Wty SOM) g LOCKE sony Me oygyelr apidtwul oh 
F454 {. AA Ro. I fap é 
Ah Miey heaving Me viccrfed Aa La, vil fi vepntle tony 
hl Onithe ty y Yor Sete 
Ue CPG SS ee Mul de fbi Mien DAW COME une wll Lie fh fe Chea 
of lhe A jected a, bt. fae Le Aosot 
Your haigelav fo wade tele fra ty Me wvesediled pily 
Moe on Sy Ctex Leth es COMLLVE tie hie ne aby / ESE enh ai fe 





fod ini de lhe finaldls ofl, 2 
Me SONG, 
Nga phe of : Oo Dosen 


- Your pied dle “ts te trek 


ee wee Lo ORG: pone Haile 
her: Banhers 





. Rescelesd. 





Be 
Sede Meena emer eee eee ona ne 
< : Eawificet: 


FIGURE 12 
Front page domestic circular letter of credit 


DOMESTIC EXCHANGE 53 


the traveler wishes to carry a large purchasing power which may be 
required for needs other than the costs of traveling, such as the pur- 
chase of supplies, stocks of goods, etc. They are issued by banks, 
exchange dealers, and express companies. 

Let us say that Jones of San Francisco is to take a three months’ 
trip during which time he is to make a number of purchases for his 


AMOUNT PAID AMOUN 
EXPRESSED IN WORDS IN 


FIGURES 





FIGURE 13 
Second page domestic circular letter of credit 


store. He must be provided with a safe and convenient means of 
carrying $50,000. His bank, the First National Bank, recommends 
a traveler’s letter of credit because traveler’s checks for that amount 
would make a rather bulky package. The bank clerk fills out a 
traveler’s letter of credit for $50,000, dates it, gives it a number, and 
also writes in the date on which it is to expire, say three months hence 
(Fig. 12). Jones signs his name in the lower left-hand corner of the 


54 DOMESTIC AND FOREIGN EXCHANGE 


page or on the front page of a small pamphlet known as a “letter of 
indication ” + (Fig. 14). 

The proper officials of the bank sign their names to the letter of 
credit and Jones is prepared for his trip. A small pamphlet is also 
given him containing a list of the correspondents of the issuing bank 
located in all parts of the country (and also, frequently, in foreign 


The Anglo & London Paris National Bank of San Francisco 


To our Correspondents,. 









Gentlemen: Ww 
We deg to advise having issued to.............¥-—4- 


our Circular Letter of Credit wo 6.>. a 


eo: eR RE or mcouenout Paty 
Signature of Payee 


LETTER OF INDICATION 


ene nee eeeeeeeeneeeeeeee rane nsnnnanarsneerenecereenenseee ee et erectesimenenneenes 


MN ft Vice-President Cashier _ 
wy Al AL bien ABV Wr. 4 _parratac z ae 





FIGURE 14 
Letter of indication 


countries) at which Jones may cash drafts drawn under his letter of 
credit. 

The letter of credit itself is a four page document, usually 8% x 10% 
inches in size. Printing appears only on the first two pages. The 
first page is a printed communication addressed to the correspondents 
of the bank, requesting them to honor the drafts of Mr. Jones when 
drawn in accordance with the terms of the credit. When Jones is in 
need of funds, he looks in the book of correspondents to see what 
bank in the city in which he is staying is a correspondent of his home 

1 Banks pursue different policies in connection with this matter. Some banks issue 
traveler’s letters of credit with the signature of the traveler appearing on the letter itself 
Other banks do not have the traveler sign the letter but furnish him with a letter of in- 
dication on the first page of which he signs his name. The traveler is advised to carry 
the letter of credit and the letter of indication in separate pieces of his luggage so that if 
one is lost the other will not be, thus guarding a little more securely against the possibility 
of forgery It usually happens, however, that the traveler carries both in the same place, 
so that really nothing is gained by the latter method. The letter of indication almost 


always is in the form of a pamphlet and, with the exception of the first page upon which 
the traveler’s signature appears, contains a list of the bank’s correspondents. 


DOMESTIC EXCHANGE 55 


bank (Fig. 15). He then presents himself and his letter at the ex- 
change window of that bank and states that he desires to draw $3,000 
against his letter. The 
clerk looks over the let- 
ter and compares it LIST OF CORRESPONDENTS 





with the set of blank UNITED STATES OF AMERICA 

. e e INDIANA 
forms which the issuing EY Old State National Banke 

a A irst an amilton National Bank. 
bank has furnished his a ary uceong oer ae 
bank at the time when McKeen ‘National Bank. 
correspondent relations 
e BURLINGTON: ..aesene 
were established. If the CEDAT. RAPIDS Rete nies Natioual Banke 
i : DES MOINES Iowa National Bank. 

letter is in the proper SIOUX CILY.< -o-nvccans Security National Bank, 
form, he compares the eae! 

3 : Leavenworth National Bank. 
signatures of the bank’s TOPEKA ES ame ar EG sao Oe 
officers appearing on KENTUCKY 
Jones’ letter with their | aA ls een 

. é LEXINGTON First and City al 
signatures appearing on LOUISVILLE. oe So. ae Bank,, 
a “signature sheet” LOUIS! 

p : . ‘BATON ROUGE ou na Wt ne Bank. 
which the issuing bank NEW ORLEANS...» bs pla of Louisiana, 
cia) avTSieietaW Fy t 
has also forwarded to | ig Sealy ns 
F MAINE 
all of its correspond- eee eae: 
N 1 ‘ 
ents (Fig. 16). When BAT pe eel poe a 
aia , : : if Boerne, National Banke 
new officials of the is- Meeting 
ms F Natio 5 
ae bank are ap Permete & Savmane nc teeel Bank 
pointed, or when a | 
new style of form is FIGURE 15 
adopted, new signature Part of correspondent list 


sheets and copies of 

the new forms must be sent to all the correspondents. If every- 
thing seems to be satisfactory, the clerk draws a draft on the 
First National Bank of San Francisco for $3,000 and on the 
draft states that it is being “Drawn under Letter of Credit 
No. 563” (the number of the letter of credit which has been 
issued to Jones). He then passes the draft to Jones to sign. Jones 
signs the draft and hands it back to the clerk. The clerk compares 
Jones’ signature on the draft with his signature on the letter of credit 
or in his letter of indication, and if they are identical, cashes the 
draft, handing Jones $3,000 minus any charge that the correspondent 
bank may make for rendering such service. Frequently no commission 


56 DOMESTIC AND FOREIGN EXCHANGE 


will be charged, and where charged it is usually of small amount. 
When the clerk cashes the draft he enters on the second page of the 
letter the amount, the date, by what bank it was cashed, and hands 
the letter to Jones. The paying bank then sends the draft to the First 
National Bank of San Francisco through the Federal Reserve check 


‘THe Frest NATIONAL BANK OF SAN PRANUISGO 


ee Fancisce; Calflania, Jam: WO47G22, 


muss leapt ip the fositent oyu thee Ge 


Clu 4te 


Vehib Nebiona .Bearrhe L Sonat She 





FIGURE 16 
First page of bank’s signature sheet 


collection system or in any other manner that it may desire. If Jones 
uses up all of his $50,000, the letter of credit is attached to the draft 
that exhausts the credit and both are returned to the First National 
Bank. 

Large banks issue their own travelers’ letters of credit, while smaller 
banks which are not so well known and which cannot afford to establish 
a list of correspondents throughout the country make arrangements 


DOMESTIC EXCHANGE 57 


with the former whereby they may issue letters of credit on them. 
The small bank will be furnished with all the necessary blanks, to- 
gether with a set of regulations and directions governing the issuance 
of such letters of credit. The blanks will bear the name of the smaller 
bank, but the letter itself will contain instructions to the correspond- 
ents that the drafts are to be drawn on the larger bank. When the 


Mr. RUDOLPH SPRECKELS, President, will sign: 


fr. JOHN P. BROOKE. Vice President, will sign; S” |. Cashier, will sign: 


ame 


Mr. C. H. McCORMICK, Vice President, will s! "S Mr. GEORGE A. KENNEDY, Vice President. will sign: 


GSA? Patines 


fu. ROBERT R. YATES, Vice Presiden yon 


atews 


oS) 


Mr L F. CADOGAN, Assistant Cashie ne Mr RK. A. NEWELL, Assistant Cashier, will sign: 
LE =A ‘aad f 


Mr. FRANK SEED, Assistant Cashier, will sign: Mc. Vs M ALVORD, Assistant Cashier, will sign. 


Mr. L, &. TOWNSEND, Assistant Cashier, will sign: t ».... Assistant Cashier, will sign. 





FIGURE 17 
Second page of bank’s signature sheet 


smaller bank issues the circular letter of credit, it notifies the larger bank 
of that fact and informs it of the amount, the person to whom issued, 
the date of expiration, and the number of the credit. As the drafts 
are drawn against the letter by the traveler, they are sent to the larger 
bank, which deducts the amounts for which they have been drawn 
from the account of the smaller bank and advises it to that effect. 

The charges made by the issuing bank to the customer vary accord- 


58 DOMESTIC AND FOREIGN EXCHANGE 


ing to circumstances. If the traveler is a depositor of the bank, and 
gets a letter of credit for a rather large amount, paying for it in ad- 
vance, he may obtain it free of charge, because the bank will have 
the use of the money, which he pays for it, during the time that the 
letter is in effect; or he may have to pay a commission varying from 
1/8 per cent to 1/2 per cent. If he is a stranger, or asks for a small 
amount, or if he doesn’t pay for it in advance but asks that the drafts 
as they come in be deducted from his account on deposit with the 
issuing bank, he will usually be charged a commission of from 1/8 per 
cent to 1/2 percent. Where the letter is purchased outright, the larger 
the amount for which it is issued and the longer the period for which 
it is to run, the lower the commission will be. This is because the 
issuing company will have the use of a larger sum of money or will 
have the use of the principal for a longer time. Thus a letter for 
$50,000 might be sold at a commission of 1/4 per cent, while one for 
$100,000 for the same length of time might be sold for 1/8 per cent. 
One for $100,000 running for 30 days might cost 1/4 per cent, while 
if it ran for six months it might cost only 1/8 per cent. 

The circular letter of credit is the favorite method of carrying large 
sums while traveling. It gives greater distinction to the traveler in 
his dealings with banks than do traveler’s checks. It serves as an 
identification of his credit standing because the correspondent that 
cashes his checks knows that if he has received his letter under a 
guarantee, his credit at the bank is satisfactory, while if he is a stranger 
to the issuing bank he has had sufficient funds to pay for it in cash. It 
usually costs less than traveler’s checks. The traveler deals with the 
correspondents of the issuing bank, with whom the latter has already 
established connections, thus making it possible for him to receive 
more courteous treatment than is usually the case when one attempts 
to cash a traveler’s check at any place other than at the office of the 
agent of the issuing company. It has the disadvantage, however, 
of compelling the traveler to cash his draft at a bank, and banks 
keep short office hours and observe legal holidays, thus occasionally 
putting the traveler to some inconvenience. 

Individual or Ordinary Drafts. Excluding the check and the bank 
draft, the individual or ordinary draft undoubtedly plays the most 
important part in domestic exchange transactions. 

A draft, as noted earlier, is an order by the first party upon a second 
party (whether it be a bank, business firm or individual), to pay a 


DOMESTIC EXCHANGE 59 


certain sum of money either at sight (on demand) or after a certain 
length of time, to a designated party or to his order. This designated 
party, the one who is to receive the money or who may order it paid 
to still another party, may be a bank, a business firm, or an individual. 
It may even be the party who has drawn the draft. 

It will be noted from the above and from what was said regarding 
a check, that the only differences between a check and a draft are (a) 
that a check is always drawn on a bank, while a draft may be drawn 
on a bank or on other parties; (b) that a check is drawn by the debtor 
to pay his obligation to a creditor, while a draft may be drawn by the 
creditor to collect funds from the debtor; and (c) that a check is 
payable always “at sight” (on demand) while a draft may be payable 
“at sight” or a certain number of days “after sight” or a certain 
number of days ‘after date.” 

A draft is drawn for the collection of money already due or to be- 
come due at some future date. It may be used in any of a number 
of financial transactions and in many different ways, but it is always 
drawn by a creditor on a debtor or on the debtor’s bank or financial 
agent. It is usually drawn with the’consent of the debtor, although 
at times it is drawn by the creditor without the knowledge or consent 
of the debtor and for the purpose of forcing payment from him. In 
the latter case, let us say that for many months Robinson has been 
waiting for Stockard to pay him for a shipment of goods. He has 
written frequently requesting payment but with no results. Finally 
he decides to draw a draft on Stockard for the amount in question 
and gives it to a bank for collection. The latter sends it to its 
correspondent bank in the city where Stockard is located. The corre- 
spondent bank presents it to Stockard for payment, who may or may 
not pay the draft. He is under no legal obligation to do so. If he does 
pay it, the correspondent collecting bank will deduct its collection 
charges and forward the remainder to Robinson’s bank. The latter 
deducts its charges and credits Robinson with the proceeds or pays him 
in cash. Thus a draft is sometimes, not frequently, used in domestic 
transactions for the purpose of compelling debtors to pay their bills. 

The draft is more customarily used, however, with the consent of the 
debtor. If Robinson sells a $1,000 shipment of goods to Bates in a 
distant city, Bates will usually advise Robinson as to how the draft 
is to be drawn, or will advise Robinson that he will agree to the draft 
being drawn according to the terms already specified by Robinson 


60 DOMESTIC AND FOREIGN EXCHANGE 


in earlier correspondence. Thus when Bates wrote or wired Robinson 
regarding the terms upon which he wished the goods to be forwarded, 
he may have specified that the draft was to be drawn on him at thirty 
days’ sight or thirty days from date; or he may have sent a commercial 
letter of credit ' authorizing Robinson to draw on Bates’ bank or 
financial agent at thirty days’ sight, or at thirty days from date, or 
for any other length of time. In all cases where the draft is drawn 
with the consent of the debtor the terms of the sale have been agreed 
upon beforehand. 

Individual or ordinary drafts are practically always collected 
through or handled by a bank or financial agency as will be seen from 
our subsequent discussion of trade acceptances and bankers’ accept- 
ances. 

Drafts may be sight or time drafts, and clean or documentary 
(collateral) drafts. A sight draft is one which is drawn “payable at 
sight” or “on demand,” i. e., when presented for payment (Fig. 18). 


















IPSS OSA SSDS SIAR LDN SSS RED biol lets it pei they | 
43 Le * ee es : 
: J So ated Satie ee 
: . ‘ : : eye eg 
+. At steht = Ff 
2 : EES es 
‘ eyes Of Reaers 
pe ee OO Ae ee eee OG 
One hovsgnd-—— me mene een oe ee ee AOE 





ni 


de Gee deretwt tsith thil tft & wove: af of . 
= £ oad 


SEALS PACS SSSI 


Soe ov 
Yes We. Bates FS Se 
ie | Wiel 2 
* A BAT Se aes 
Sig New York { 
Beige PEL SLL LL ELLA ESL LEE V EL SPSL D EOL ESLER AD DEPOSED ILO 


FIGURE 18 
Sight draft 


A time draft may be made payable at so many days “after sight,” 
i. e., so many days after it has been “accepted” or honored (Fig. 19), 
or it may be drawn payable so many days “after date,”’ i. e., after the 
date appearing on the date line of the draft (Fig. 20). When the party 
upon whom a draft has been drawn payable say thirty days after sight, 
desires to honor it and agrees to pay in accordance with the amount 
and terms stated on its face, he “accepts”? or honors the draft by 
writing across its face the word “Accepted,” and the date, his name, 
and also at times the place at which or the bank by which the draft 
will be paid. The draft then becomes an “acceptance” and the 


1 Cf. pp. 70-73 for discussion of commercial letter of credit in domestic trade. 


DOMESTIC EXCHANGE 61 


drawee becomes the “acceptor.’”’ This type of time draft is far the 
more common, in fact it is the usual type employed in financing both 
domestic and foreign trade. 

Clean drafts, more commonly known, both in domestic and in 
foreign exchange transactions, as “clean bills,” are those bills or drafts 


peceeerert 






ieee Set Aomesomimea as Les orentetiiteim os Aso Satta ns isnopeostossgubsise 
ig : te ; 


; 







Jy. ono.c8 


eee? of WEBEL scsi 


x 
seer Se 





One ShSusAnde —~—— somn ee ‘* 





i . Lalu wach tah hiige be Mews ae 

de RG sy BBLS es : E : 
: vy a aw Sore 
eee PIER EES ELS, LES OL ELUTED VOSA DILL LOD AD ERT Te . 


FIGURE 19 
Ninety day sight draft 


which have no documents attached. When Robinson drew on Stock- 
ard to compel him to pay, Robinson simply drew a draft to 
which nothing was attached. This wasa “clean” draft or a “clean” 
bill. However, when he shipped goods to Bates and drew his draft 
on Bates, or on Bates’ bank or financial agent, he most likely attached 











Apel. Ms 
ee iy ie de: 


pe : a 
MEL Of ee EBOAE 


 Rimaty guys from Gate 











oo yy, “ Ma beis Be 





Cue sousend--~<<= 





Like ee 


ie Wie REGO ee 










i ~ Pc Sent tae sabe Ube ey on Sere : 
; : SORES IR LSPS BOREAS OT on. POE 





FIGURE 20 
Date draft 


shipping or other documents which carried title to the goods. We 
shall later discuss this practice and the reasons therefor. The attach- 
ing of documents to a draft makes it a “collateral” draft, or, as it 
is more commonly known, a “documentary” draft. The documents 
act as security or as collateral for the draft. Documentary bills of 


62 DOMESTIC AND FOREIGN EXCHANGE 


exchange play an extremely important part in the financing of domestic 
and foreign trade, being the most common form of exchange used in 
that connection. We shall henceforth know this class of drafts as 
“documentary bills.” When a thirty or sixty day sight draft has 
been accepted and the documents have been turned over to the ac- 
ceptor, the draft will then have no documents attached, and will thus 
become a “‘clean”’ draft. 

An interesting practice has grown up in connection with the use 
of the draft in the sale of stocks and bonds, both in domestic and 
foreign transactions. A customer in Chicago will instruct a firm 
in New York to buy for him a certain amount of stocks or bonds and 
to draw on him for the amount covering their cost plus the commission 
of the agent. The agent fulfills the engagement and draws on the 
buyer as requested. He attaches the draft to the stocks or bonds 
with the instructions that they are not to be turned over to the buyer 
until the latter has paid the draft. The draft and the securities are 
given to a bank for collection, or are sold directly to a bank, the at- 
tached stocks or bonds acting as “backing” or security for the draft. 
Such a draft, however, is technically known as a “collateral” draft, 
not a “documentary” draft. Stocks and bonds are not “documents” 
which give possession to property being shipped by another route; 
they are themselves the property involved in the transaction. 

The use of the draft in domestic business relations is a most interest- 
ing study, and it is regretted that it is not possible in this volume to 
enter into a detailed discussion thereof. The most important phases 
only will be sketched, in order to show the part which the individual 
draft plays in the financing of our domestic trade. 

Trade Acceptances. For many years it has been customary for the 
American business man to sell goods to his customer and merely enter 
the amount of the sale on his books as charged to the account of the 
buyer. This is known as the “open book account” method. When 
the goods are shipped, the seller sends a bill to the buyer with a state- 
ment that if paid at once or within a period of ten days the buyer 
will receive a deduction or rebate of one, two, or possibly as high 
as five per cent of the amount of the bill, an effort thus being made 
to induce the buyer to remit cash upon receipt of the bill. This deduc- 
tion or rebate is known as a “cash discount.” 

On the face of it, it would appear that the buyer would be eager to 
remit cash in order to obtain the discount, but in actual practice, on 


DOMESTIC EXCHANGE 63 


the contrary, it has been customary for the buyer to wait until he is 
“good and ready” before remitting for the goods purchased. One 
two, or three months, or possibly a longer period may elapse before 
payment is made. In reality, the seller finances the business of the 
buyer, supplying him with goods to sell and then waiting for him to 
remit. Under such conditions the seller at times has been placed in a 
very unsatisfactory financial position. It might happen that he would 
have on his books a large number of “accounts payable.”’ He might 
need funds with which to conduct his own business, and yet find him- 
self unable to collect from his customers. He has received nothing 
from them in the shape of a promissory note or an accepted draft to 
show just when they would pay. Consequently if he wished to obtain 
additional funds for his business he might have to do one of three 
things: (a) sell his accounts outright to the bank, which would charge 
him a high commission for receiving them because it would have to 
assume the risks attendant upon their collection; (b) use them as se- 
curity in applying for a loan, assigning them to the party loaning 
him the money. ‘This again is unsatisfactory because the margin of 
safety required by the lender would be rather large since there is no 
way of knowing just what percentage might be realized on the ac- 
counts in case the borrower could not meet his loan when it fell due. 
(c) Or the seller might place the accounts in the hands of a collection 
agency, which would undoubtedly lose him the business of his cus- 
tomers. This system of book accounts has been productive of bad 
debts, undue extension of payments, cancellation of orders, slow col- 
lections, and losses, all entailing heavy burdens upon business opera- 
tions. It has, also, naturally resulted in higher prices to the buyer. 
Book accounts are not the proper kind of short time investments for 
banks. In fact, practically nothing good can be said of the system 
of open book accounts. 

For a long time there has been a demand that American business 
men develop and use the “trade acceptance” for the financing of 
domestic trade. The reason why no progress was made in that direc- 
tion until after the enactment and amendment of the Federal Reserve 
law was because there was no open discount market in the United 
States. There was no place where banks could take the commercial 
paper which they had discounted or bought from their customers and 
sell it, i. e., rediscount it. Such a discount market has existed in the 
European countries which for years past have financed their internal 


64 DOMESTIC AND FOREIGN EXCHANGE 


trade to a very large extent by means of the trade acceptance.! But 
American banks had not been educated to an appreciation of the 
practice and advantages of rediscounting bills. If they got hard 
pressed for funds and sold some of their first class discounted commer- 
cial paper to a friendly bank, it was felt that such an action was evi- 
dence of the financial weakness of the banks resorting to it. The 
enactment of the Federal Reserve law, its amendments, and the regu- 
lations of the Federal Reserve Board, have done much to remove the 
“stigma which may have attached to rediscounting in the past” ? 
so that today a very considerable progress has been made in the use 
of both trade and bank acceptances in financing domestic business. 

In general an acceptance may be defined as a bill of exchange, pay- 
able at a fixed or determinable future date, the obligation to pay being 
acknowledged in writing on the face of the bill either by the person 
to whom it is addressed or by some other party. This is usually done 
by writing the word “Accepted,” also the date, followed by the signa- 
ture of the acceptor, although legally the signature and date only ‘on 
the face of the draft are sufficient. Frequently the acceptor will 
designate the place at which or the bank by which the acceptance is 
to be paid. When the draft is drawn by the seller upon the buyer and 
accepted by him (or by some other party “for honor” *) it is known 
as a “trade acceptance.’’ Bank acceptances will be discussed in the 
next section of this chapter. To be eligible for rediscount at a Federal 
Reserve bank, the acceptance must bear on its face the words “The 


1 The following, from the New York Times of July 27, toro, is of interest in connection 
with the methods now being followed by English firms in financing their internal trade: 

“At a time when so much is being done in the United States to stimulate the use of the 
trade acceptance in domestic business it may be of interest to know what British practice 
is in this regard. 

“*“The domestic trade acceptance,’ explains Trade Commissioner Henry F. Grady, ‘was 
very generally used thirty or thirty-five years ago, but its use has since been practically 
discontinued. The bank acceptance is used universally in foreign business, but in domestic 
business the banks make advances and permit overdrafts as the accredited method of 
financing trade. 

““«The five large joint-stock banks which have branches throughout the United Kingdom 
and control about 70 per cent of the banking business of the country use the overdraft ~ 
very extensively. The overdraft is used particularly in the case of the very large firms. 
It does not follow, of course, that advances made in this form are unsecured. The custom 
is to keep with the bank as a reserve against which to secure advances, a certain amount 
of securities, this being true whether the advance is to be an overdraft or a loan. To ob- 
tain an overdraft the firm calls on or writes the bank and advises it that it wishes to over- 
draw its account for a prescribed amount, and the bank then honors checks against it for 
approximately that amount—the sum is never rigid, and the extent of the overdraft is 
left to the requirements of the firm.’ ”’ 

2 Holdsworth, J. T., ‘‘Money and Banking,” New York, 1917 ed. p. 268. 

3 Cf. pp. 86-87. 


DOMESTIC EXCHANGE 65 


obligation of the acceptor of this bill arises out of the purchase of 
goods from the drawer,” or it must be accompanied by a certificate 
bearing a statement to the same effect. Federal Reserve banks re- 
discount acceptances only for member banks. 

Trade acceptances arise in the following manner: Robinson of New 
York sells Stockard of New Orleans $5,000 worth of steel. He takes 
the steel to the railroad company for shipment and receives a bill of 
lading. The bill of lading is a receipt from the carrier stating that it 
has received goods from the shipper for transport to a certain point. 
If a bill of lading is made out showing that the goods are consigned 
or destined to a certain party, it is known as a “straight ” bill of lad- 
ing. If, on the other hand, it is made out showing that the goods 
are consigned to the order of a certain party, usually the seller, it is 
known as an “order” bill of lading. A straight bill of lading is nor- 
mally not negotiable, i. e., not capable of being indorsed and delivered 
to another person (as a check would be under ordinary circumstances), 
thereby transferring title to the goods. Usually the shipper has the 
railway company make the bill of lading out to himself “ or order,” 
which means that the title to the goods rests with him until he trans- 
fers it to another person by writing an indorsement across its face. 
An “ order ” bill of lading is negotiable and is the form ordinarily met 
with in both domestic and foreign trade. In domestic trade, however, 
the straight bill of lading is frequently used in connection with trade 
acceptance transactions. 

Robinson, having received his order bill of lading from the shipping 
company, attaches an invoice, which is simply a statement of the 
goods shipped, and draws a draft on Stockard. Let us say that it is 
a thirty day sight draft. Robinson pins the three documents together, 
thus constituting what is known as a “ domestic documentary bill of 
exchange.”’ Sometimes, but not frequently, the documents are drawn 
in duplicate as a precaution against loss in the mails. If Robinson 
has faith in the credit standing of Stockard, he may send the docu- 


1 It is not deemed necessary or advisable to present a discussion of the rules and regu- 
lations of the Federal Reserve Board regarding the eligibility of commercial paper for 
rediscount or the extent to which member banks may engage in the acceptance business. 
Such matters may be easily found by consulting any standard book written since 1917 
dealing with the subject of Banking or the Federal Reserve law. Cf. Holdsworth, J. T., 
“Money and Banking”; Willis, H. P., ““The Federal Reserve Act’; Kemmerer, E. W., 
“The A. B. C. of the Federal Reserve System,” etc. Cf. also the Federal Reserve Bulletin 
and the annual reports of the Federal Reserve Board. 

In 1920 the Federal Reserve banks rediscounted $192,157,000 in trade acceptances for 
member banks and purchased $74,627,000 worth of them in the open market. 


66 DOMESTIC AND FOREIGN EXCHANGE 


mentary bill (with a straight bill of lading) direct to him, ask him 
to accept the draft, and to return the accepted draft. Robinson may 
hold the accepted draft until about the time of its maturity and then 
hand it to his bank for collection, or he may sell it to his bank (discount 
it) at any time before maturity. During the last few years many firms 
have been attempting to induce their customers to adopt the trade 
acceptance practice by sending the bill to them in two different forms 
accompanied by a straight bill of lading. One form embodies the old 
idea of the open book account method, being just a statement of the 
amount of money due the seller and a note to the effect that if paid 
at any time within ten days a discount of a certain percentage will 
be given the purchaser. The other form is in the shape of a trade 
acceptance to be accepted by the purchaser, payable, say, at the end 
of thirty days. The customer thus has the alternative of resorting to 
either the trade acceptance or the open book account method. 

In Robinson’s case, above, it may be that after preparing his docu- 
mentary bill of exchange he asks his bank to purchase it (discount it) 
before acceptance by Stockard, or to take it for collection. If the 
bank discounts it for him, it may pay him immediately, or it may 
wait until it has been notified by its New Orleans correspondent of 
Stockard’s acceptance. When the bank discounts the bill for Robin- 
son it will pay him a sum of money slightly less than the face value 
of the draft. The bank has really purchased his claim to $5,000 thirty 
days hence, and, having to wait that long for its money, it imposes a 
small charge for the accommodation rendered. If the market rate of 
discount prevailing at that time is 6 per cent for bills of the kind under 
discussion, the bank will charge a sum equal to 6 per cent for thirty 
days on $5,000, 1. e., $25, and will hand Robinson the remaining $4,975. 
If the bank takes the draft for collection, however, Robinson will get 
his money after it has been collected, i. e., thirty days hence, less the 
bank’s collection charges. Or Robinson may hand the documentary 
bill to his bank to be presented to Stockard by the New Orleans corre- 
spondent merely to secure Stockard’s acceptance. After having been 
accepted, the draft in this case will be returned to Robinson for 
his keeping, or, if he desires, it may be retained by the New Orleans 
bank until paid, or until Robinson orders the New Orleans bank to 
discount it, the funds to be remitted to him through the New York 
bank or to be credited by the New Orleans bank to his ac- 
count. 


DOMESTIC EXCHANGE 67 


Among bankers, discounting is commonly looked upon as “taking 
out interest ahead of time” or “taking interest in advance.” They 
purchase commercial paper which is due and payable at a certain 
future date, thus advancing the money prior to the time when it is 
actually due. It is necessary for them, therefore, to calculate the 
present worth of the future payment. The amount that is deducted 
from the face value of the bill is known as the “discount.” The “rate 
of discount” is the percentage per year relation which the amount 
of the discount bears to the sum that is to be collected by the dis- 
counting bank at the maturity of the discounted paper. ‘“ Re-dis- 
counting” is merely discounting again, i. e., the act of either selling 
or buying a bill which has already been discounted. The verbs “to 
discount” and “to re-discount” apply to the action of either 
the buyer or the seller of the bill. You “discount” your com- 
mercial paper at the bank, and the bank “discounts” it for you. 
A bank “rediscounts” its discounted bills at the Federal Reserve 
bank, and the Federal Reserve bank “re-discounts”’ them for the 
bank. 

If you draw a sixty day draft for $1,000 and present it immediately 
to the bank for discounting, and if the bank buys it at a discount rate 
of 6 per cent, it pays you $990, which is the present worth of $1,000 
sixty days hence. Six per cent on $1,000 for a year is $60. Sixty days 
is one-sixth of a year, taking 360 days to the year, which is the custom- 
ary American practice. One-sixth of $60 is $10, the discount deducted 
by the bank. The bank, of course, collects the full sum of $1,000 sixty 
days hence when the draft matures. On the other hand, if you were 
to borrow $990 from the bank as an ordinary loan, agreeing to pay 
six per cent on the loan at the end of sixty days, you would pay back 
to the bank the sum of $999.90, or slightly less than the bank would 
have received had it discounted a $1,000 commercial bill. Discounting 
at the same rate that prevails for the loaning of money at interest 
really nets the bank a slightly larger return. 

If the bank holds your sixty-day draft for thirty days and then 
presents it to a Federal Reserve bank for rediscounting, the latter 
will have to carry the unpaid claim for the remaining thirty days. 
If, to make our problem simple, the rediscount rate of the Federal 
Reserve bank happens to be the same as the discount rate of your 
bank (which supposition is seldom true), the Federal Reserve bank 
would pay $995 for your draft, thus obtaining $5 on its investment for 


68 DOMESTIC AND FOREIGN EXCHANGE 


thirty days and at the same time giving your bank its discount for 
the thirty days during which it had carried the claim.! 

Reverting to our example of Robinson and his documentary bill 
of exchange, let us say that he sells it to his New York bank. He in- 
dorses the draft on the back; he also indorses the bill of lading but 
by signing his name on its face. He then turns all the documents over 
to the bank, thus transferring title and claim to the goods to the buy- 
ing or discounting bank. The bank indorses the documents and sends 
them to its correspondent in New Orleans. The New Orleans bank 
presents the draft to Stockard for his acceptance. He accepts the 
draft by writing across the face of the draft the word “Accepted,” 
and signs his name and the date, or he may omit the word “ Accepted” 
and merely sign his name and the date. In either case the draft has’ 
become a “trade acceptance ” (Fig. 21). Stockard, after accepting 





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ve J. Ge Stockard ( ; 

seep “ oO 3 

Se fee a New Orlesre 

GULEL ERLE LIES SD SESS METS LESSORS Dy etnies | ! 


FIGURE 21 
Trade acceptance 


the draft, hands it to the bank clerk, and the bank turns over to him 
the bill of lading, the invoice, and any other documents that may 
have accompanied the draft. The New Orleans bank, acting under 
instructions received from the New York bank, may or may not take 
from him security in the form of stocks, bonds, mortgages, or any other 


1 Tt is the policy of the European central banks, the most important rediscounting agencies 
in their respective countries, to keep their rate of discount (or rediscount) above the market 
rate for money, otherwise they would be overwhelmed with offers of bills for rediscount. 
The Federal Reserve banks, however “‘have adopted the policy of keeping their buying 
rates more closely in line with the rates at which bills were offered in the open market by 
purchasing only at or slightly below those rates.” (Sixth Annual Report, Federal Reserve 
Board, 1919, p. 23.) In 1921 they even scaled down their discount rates in advance of the 
declining market rates. For example, the Federal Reserve Bank of New York adopted 
a 41% per cent rate of discount when the market rates for prime commercial paper, short- 
dated time paper, and longer dated maturities were respectively 5-514 per cent, 5-534 per 
cent and 514-5 !% per cent. 


DOMESTIC EXCHANGE 69 


kind of security so as to protect the New York bank in case of non- 
payment. In the absence of instructions, it is required by law to turn 
over the documents upon acceptance. The New Orleans bank holds 
the draft subject to the orders of the New York institution, and may 
hold it until maturity at which time the New Orleans bank will present 
it to Stockard for payment. When paid, the funds are credited to 
the account of the New York bank or remitted to it, depending upon 
the instructions received from the latter. Let us say that when 
Stockard accepted the draft he made it payable at his bank, the 
Cotton National of New Orleans. The draft would then be presented 
to the Cotton National Bank on the day of its maturity, and would 
be paid by that bank out of the deposit account of Stockard without 
his giving the bank any further order than that authorized by his 
having written the words “Payable at the Cotton National Bank” 
on the face of the draft.? 

Let us say that ten days after Stockard accepts the draft, the New 
York bank notifies its New Orleans correspondent to take the draft 
to the New Orleans branch of the Federal Reserve Bank of Atlanta 
and have it rediscounted. The New Orleans branch of the Federal 
Reserve Bank of Atlanta rediscounts the draft and credits the dis- 
counting bank with the discounted face value of the draft, or, acting 
upon orders from the latter, it may transfer the funds to the New York 
bank by means of a telegraphic transfer. The discounted bill may 
then be used by the Federal Reserve Bank of Atlanta, the parent of the 
New Orleans branch, as partial security behind the issuance of Federal 
Reserve notes, provided it desires to do so. When the draft falls due, 
the New Orleans branch of the Federal Reserve Bank of Atlanta will 


1 The report of the Acceptance Committee of the American Bankers Association (May 2, 
1921), comments as follows on this point: 

“One of our greatest problems is to bring about a clearer understanding on the part 
of bankers as to what the trade acceptance is, its proper use, true method of operation 
and particularly its final disposition when made payable at a bank. Judge Thomas B. 
Paton, General Counsel of the American Bankers’ Association, in a recent decision, the 
full text of which appears on page 684 of the April ‘‘Journal of the American Bankers’ 
Association,” stated: ‘Where the drawee of a trade acceptance makes it payable at a bank, 
it is equivalent (except in certain States) to an order to the bank to pay, and there is no 
need of express instructions as to prerequisite to payment. A bank which refuses payment 
having sufficient funds of its customer would be liable to him for injuring his credit.’ 

“Section 87 of the Negotiable Instruments Act, as operative in all States except Illinois, 
Kansas, Minnesota, Missouri, Nebraska and South Dakota, provides that when an instru- 
ment is made payable at a bank it is equivalent to an order on the bank to pay the sum 
for the account of the principal debtor thereon, which in the case of trade acceptances is 
the acceptor. If banks would observe this rule of law, the handling of trade acceptances 
would be greatly facilitated and many complaints and disputes would be obviated.” 


79 DOMESTIC AND FOREIGN EXCHANGE 


collect the draft from Stockard just as the New Orleans correspondent 
would have done had it held the draft until maturity. 

The advantages of a trade acceptance over the old open book ac- 
count system are evident. Robinson can get his money whenever he 
wants it by discounting the draft either before or after acceptance 
by Stockard. He can keep his assets in more liquid form and his 
business in better condition. Banks are provided with a means of 
investing their funds for short time periods and receive therefor the dis- 
count at the rates charged. If they are pressed for funds at any time 
they may easily rediscount acceptances, if in proper form, at a Federal 
Reserve bank or its branch. They can therefore keep themselves in 
a much better financial condition than might otherwise be the case. 
Stockard by his acceptance definitely agrees to pay the draft when it 
falls due and is thereby enabled to obtain better prices from Robinson. 
The Federal Reserve banks also are supplied with satisfactory com- 
mercial paper to use as partial security for the issuance of Federal 
Reserve notes with which to supply the fluctuating needs of business. 
From the point of view of all parties concerned, therefore, the trade 
acceptance is superior to the open book account system. 

It has been very difficult to induce the American merchant to use 
the trade acceptance method of financing domestic trade although 
there has been much propaganda toward that end. National as- 
sociations of merchants and bankers have gone on record as favoring 
it and have spent much time and money in furthering its cause. A 
“National Trade Acceptance Council” has also been established 
whose object is to popularize the use of the trade acceptance. State 
and national banking laws have been modified to encourage its de- 
velopment. The results thus far obtained have indeed been very 
satisfactory.! 

Bank or Bankers’ Acceptances. Closely akin to the trade accept- 
ance is the bank or bankers’ acceptance. A bank acceptance may be 

1A recent report of the Acceptance Committee of the American Bankers’ Association 
contains the following statement: 

“In 1916 the known users of trade acceptances in America numbered 185. In October, 
1921, the list exceeded 20,000. The number has grown steadily and now includes prac- 
tically every line of business that makes sales on the time basis. Where the trade accept- 
ance has been properly and legitimately used, the results have been eminently satisfactory. 
It has shortened the credit period, it has made collections more certain; it has enabled an 
equal amount of capital to do a greater amount of service; it has eliminated many trouble- 
some claims and disputes; it has reduced the expense of operation both for the buyer and 


seller; it has stabilized the businesses involved and has produced a character of strictly 
liquid paper.” 


DOMESTIC EXCHANGE 71 


defined as a bill of exchange or draft, payable at a fixed or determin- 
able future date, upon the face of which has been acknowledged in 





) 2. 5871. Gedy 


& 10,000 °°/100 





























holy up i wth ae hollors thal alldiafésy 
ed reaccoldarice. wilhlbewibtin bifpulided hind, 
theo? ZZ above named ae be Fa vi 







NG, Onarts Drawn uwneR THs CREDIT 
| MUST BEAR THE CLAUSE * ORAWN UNDER — 
ee eid OF Ghepst 






FIGURE 22—Domestic commercial letter of credit 


writing the unconditional obligation of the bank or other financial 
agent on which it is drawn to pay the same at maturity.’ In this 


1The Federal Reserve Board has defined a bankers’ acceptance as ‘‘a draft or bill of 
exchange, whether payable in the United States or abroad, and whether payable in dollars 


72 DOMESTIC AND FOREIGN EXCHANGE 


case the seller draws his draft on a bank, not on the buyer. To do this, 
the buyer gets from his bank a document known as a “commercial 
letter of credit.” This is usually in the form of a printed letter (al- 
though sometimes it is typewritten), with the necessary blanks filled 
in on the typewriter or in ink, advising the seller that he is authorized 
to draw on the bank for a certain sum of money, the draft to run for 
a certain number of days, etc. The letter contains full and complete 
instructions to the seller informing him how many and what kind of 
bills of lading he must get from the carrier, what documents he must 
forward and how they are to be drawn and indorsed, before what date 
the draft must be drawn and the shipment made, etc. Let us say 
that McGraw of San Francisco desires to have Robinson of New York 
ship him $10,000 worth of rope. Robinson doesn’t know McGraw 
or his credit standing and would hesitate to draw a draft on him or to 
give him open unsecured credit. So McGraw goes to his San Francisco 
bank, let us say the Anglo and London Paris National Bank, and 
obtains from it a commercial letter of credit addressed to Robinson 
(Fig. 22). A commercial letter of credit is usually a four page letter 
with printing appearing only on the first page. As will be noted from 
the accompanying form, it authorizes Robinson to draw on the Anglo 
and London Paris National Bank of San Francisco up to the sum of 
$10,000, before a certain date, and advises him as to how the ship- 
ment is to be made, what documents must be provided, etc. 
McGraw sends this letter to Robinson, or may instruct the bank 
to forward it. McGraw also instructs Robinson regarding how the 
rope is to be sent, over what transportation lines, etc. Robinson packs 
the rope, gets the necessary documents from the shipping company, 
and draws his draft not on McGraw but on the Anglo and London 
Paris National Bank of San Francisco. He may then sell the draft 
to his New York bank or it may be handled by him in any of the 
methods mentioned in connection with our description of the trade 
acceptance. Let us say that the New York bank discounts the draft. 
It pays a little higher amount for such a draft, i. e., it charges a lower 
rate of discount, than it would for a trade acceptance, because it is a 
draft on a bank, not on an individual, with consequently less risk of 
non-payment. The documentary bill is then sent to its San Francisco 


or some other money, of which the acceptor is a bank or trust company, or a firm, person, 
company, or corporation engaged generally in the business of granting bankers’ acceptance 
credits.”” Regulations A, Series 1920, VI, B. 


DOMESTIC EXCHANGE 73 


correspondent with the request that it be presented to the Anglo and 
London Paris National Bank for acceptance. The latter will accept 
the draft and the documents will be turned over to it without its 
furnishing any security. Its acceptance is sufficient. Instructions 
as to just how the transaction is to be handled are always sent to the 
correspondent bank by the discounting bank. Let us say that the 
San Francisco correspondent bank, acting on instructions from the 
New York bank, discounts the acceptance at the local Federal Re- 
serve bank. 

The Anglo and London Paris National Bank notifies McGraw that 
it has the documents covering the shipment. He comes to the bank 
and receives the documents upon furnishing the proper security, or 
if he has excellent credit, he is given the documents without furnishing 
any security, although he would normally be required to execute a 
trust receipt in favor of the bank.! He then gets his goods and pays 
nothing until the draft falls due. A day or so before the draft matures, 
he “puts the bank in funds,” i. e., he gives the bank the money with 
which to pay the maturing draft plus the commission (usually about 
14 of one per cent) charged by the bank for the service rendered. On 
the day of the maturity of the draft, the Federal Reserve Bank of 
San Francisco presents the draft to the Anglo and London Paris Na- 
tional Bank for payment. The latter will pay the face value of the 
draft, McGraw, in the meantime, as has been noted, having “put the 
bank in funds.” 

The Guaranty Trust Company of New York in one of its pamphlets 
on this matter, summarizes the numerous advantages of the bank 
acceptance as follows: 


(1) Bank customers can ordinarily borrow by this means more cheaply 
than by their straight note. 

(2) The use of acceptances makes it possible for banks and trust com- 
panies to properly and conveniently finance legitimate business transac- 
tions of their customers without using any of the bank’s funds or the use 
of any additional funds. 

(3) Banks having surplus money which cannot be readily employed at 
the time can invest it in prime acceptances, which can either be held until 
maturity or sold in the open market, should such action be found necessary. 
It is obvious that prime bank acceptances, backed as they are by well- 
known banks or trust companies, and readily rediscountable, can find eager 


1 Cf. pp. 245-250 for an extended discussion of the trust receipt. 


74 DOMESTIC AND FOREIGN EXCHANGE 


purchasers by virtue of their high intrinsic security as the most liquid form 
of investment for banking institutions. Aside from cash in the vault noth- 
ing is so rapidly liquidated, especially in view of the existing Federal Re- 
serve system. 

(4) Acceptances of well-known institutions will more and more be sought 
as short-term investments and will be especially valuable for such a pur: 
pose, principally on account of their ready marketability. 

(5) Banks and trust companies can accept for a commission the paper 
issued by their best customers and sell it in the open market, thus adding 
to their business another feature which can be a source of definite 
profit. 

(6) The presence of the name of the accepting bank makes prime to the 
extent of the credit of the accepting bank the paper on which it appears. 
This at once eliminates the necessity and bother of checking the drawer 
or several indorsers upon paper, as the primary responsibility rests with 
the accepting bank. If this is in good credit all other names on the papef 
become proportionately of less interest. 

(7) With the development of the use of bank acceptances, the knowledge 
of the relations that the borrower has with other institutions, which the 
credit-extending banks will thus have, will create a condition of almost 
automatic registration of paper; thus more than ever protecting the banks 
as well as the borrowers from the evil results of the over-extension of credit. 


The buyer advances no funds, but finances the transaction through 
the credit advanced by the accepting bank. The seller knows that he 
is sure of his money, because the draft is drawn on a bank. He does 
not know the buyer or his credit standing, but the substitution of 
the banks’ credit for that of the buyer makes him willing to sell with- 
out any hesitancy. The drawer is also able to realize a little higher 
amount on a draft drawn under a commercial letter of credit because 
the discounting bank will charge a little lower rate of discount for a 
bank acceptance than for a trade acceptance. Likewise in the past 
the rates of rediscount charged by the Federal Reserve banks have 
been slightly lower for bank acceptances than for trade acceptances,} 


1 The rates of rediscount charged by the Federal Reserve banks on March 25, 1921, 
were as shown on opposite page. 

“Note: Rates shown for St. Louis and Kansas City are normal rates, applying to dis- 
counts not in excess of basic lines fixed for each member bank by the Federal Reserve Bank. 
Rates on discounts in excess of the basic line are subject to a % per cent progressive in- 
crease for each 25 per cent by which the amount of accommodation extended exceeds the 
basic line, except that in the case of Kansas City the maximum rate is 12 per cent.” 

It will be noted that in the case of eight banks out of the twelve the rate of rediscounting 
trade acceptances was higher than that charged for rediscounting bank acceptances. 


DOMESTIC EXCHANGE 75 


although at the time of this writing (April, 1922) the same rediscount 
rates apply to both kinds of paper.! 

Federal Reserve banks are authorized to rediscount bank accept- 
ances of member banks or to purchase them in the open market ” 
(with or without their bearing the indorsement of a member bank), 
from banks, firms, corporations, or individuals, provided they fulfill 
all the requirements for eligibility prescribed by the Federal Reserve 
Board. As eligibility for rediscounting at the Federal Reserve banks 
has an important bearing on their marketability, we find such bills 
classified into three groups: (1) “Eligible bills of member banks,” (2) 
“Eligible bills of non-member banks,” and (3) “Ineligible bills,” 
with different rates of discount applying to each class. Some of the 
more important requirements concerning eligibility are to the effect 
that the acceptance must have a maturity of not more than three 
months,’ exclusive of days of grace, and must have been drawn to 


“DISCOUNT RATES OF THE FEDERAL RESERVE BANKS IN EFFECT MARCH 25, Ig921 


| Discounted bills maturing within 
go days (including member banks’ 


15-day collateral notes) secured by| Bankers’ Agricul- 
$$ ——_—_—_—| accept- Trade tural and 
Treasury | Liberty Other- ances accept- live-stock 
certifi- bonds wise disc’ted ances paper 
cates of and secured for maturing | maturing 
indebt- Victory and member within gt to 180 
edness notes unsecured] banks go days days 
PPOs BG oka: 2 5% 6 a oe 7 7 
INGWV OF oso ess. 6 6 7 6 7 7 
Philadelphia....... as 5% 6 6 6 6 
(Seveland ks: 6 6 6 6 6 6 
RIeMIONC os cs ss 6 6 6 6 6 6 
LSC te 6 5% 7 6 7 7 
SeINCARU Rte. osc a's 6 6 7 6 7 7 
BER GUIS A. sus hs ts 6 5% 6 5% 6 6 
Minneapolis....... 5% 6 7 6 6% 7 
Pansas Cy... . *6 6 6 5% 6 6 
RAS wea Pa. sss 6 6 7 6 7 7 
San Francisco..... 6 6 6 6 6 6 





““* Tiscount rate corresponds with interest rate borne by certificates pledged as col- 
lateral with minimum of 5 per cent in the case of Kansas City and 5% per cent in the case of 
Philadelphia. 

1On April 1, 1922, the rates of rediscount for all kinds of paper were 4% per cent for the 
Federal Reserve banks of Boston, New York, Philadelphia, and San Francisco, and 
5 per cent for the other Federal Reserve banks. 

2During 1920 the Federal Reserve banks discounted $187,162,000 worth of bankers’ 
acceptances for member banks and purchased $3,143,737,000 worth in the open market. 

3 On May 6, 1921, the Federal Reserve Board issued what were taken to be temporary 
regulations, permitting Federal Reserve banks to purchase bankers’ acceptances with six 
months maturities growing out of foreign trade transactions. The regulation was to re- 


76 DOMESTIC AND FOREIGN EXCHANGE 


finance the foreign or domestic shipment of goods, or the storage of 
readily marketable staples, or to create dollar exchange.? Evi- 


At the time of acceptance, this bill was accom- 
panied by shipping documents evidencing the 


(name of commodity) 
domestic shipment of 


(point of shipment) 


ACO) MA Peis. 
(date of acceptance) 


PAYABLE AT 
(name of bank) 





FIGURE 23 


Form of statement approved by the Federal Reserve Board to be stamped 
or printed on bank acceptances covering domestic shipments, or to 
appear on an accompanying certificate. Similar statements are used in 
case of warehoused goods. 


dence of eligibility indicating the character of the transaction must 
appear on the face of the acceptance or on an accompanying cer- 
tificate (Fig. 23). 


main effective “‘until further notice”? and was designed for the purpose of trying ‘‘to widen 
the acceptance market” and ‘‘to provide more ample facilities for financing import and 
export trade.” 

1“ A clothing manufacturer, for example, desires to carry his stock of wool through the 
use of bankers’ acceptances. He places the wool in a warehouse, draws a draft on his bank 





Cf. pex3s: 


DOMESTIC EXCHANGE 9 


The bank acceptances of member banks are classed as “eligible” 
provided the requirements of the Federal Reserve Board have been 
fulfilled. Non-member banks and bankers may make their accept- 
ances “eligible ” and thus purchasable by the Federal Reserve banks 
in the open market by filing with the purchasing Federal Reserve 
bank a statement of financial condition in the form approved by the 
Federal Reserve Board. They must also agree in writing to inform 
the Federal Reserve bank upon request concerning any transactions 
covered by their acceptances. Other bank acceptances which the 
Federal Reserve banks cannot purchase or rediscount are called “in- 
eligible.” The first group commands the best or lowest rates of dis- 
count in the open market, while the “ineligible” bills command the 
highest or least satisfactory discount rates, as is shown by the follow- 
ing table: 


BANK ACCEPTANCE DISCOUNT RATES IN OPEN MARKET, NEW YORK, 
MARCH 21-26, 1921 


Delivery 
Ninety Sixty Thirty within 
Days Days Days 30 days 


Eligible bills of mem- 

ber banks..... +. ..6-1/8 @ 6 6 @s-7/8 5-7/8 @ 5-34 .6-% bid 
Eligible bills of non- 

member banks.....6-'44 @6% 6% @6 6-1/8 @ 5-7/8 6-5/8 bid 
Ineligible bills. ...... 7 @6% 7 @6% $7 @6% 7 bid 


As yet bankers’ acceptances are not used to any extent in domestic 
trade because other satisfactory means are provided for its financing. 
In Chapter IX we shall discuss in detail their use in foreign trade. 
One reason why they have not been more widely used in domestic 
circles is that until lately national banks and the banks of practically 
all states have not been allowed to accept drafts arising out of either 
domestic or foreign trade. The Federal Reserve Act of 1913 au- 


for the value'of the wool, attaching the warehouse receipts as collateral. The draft, after 
acceptance, is returned to him to be sold, the warehouse receipts being retained by the 
bank. The wool must be stored in a warehouse which is independent of the manufacturer; 
that is, the manufacturer must not have any control of the wool as long as the warehouse 
receipts are outstanding. It is, of course, possible to secure possession of the original ware- 
house receipts by substituting other warehouse receipts for wool, but if the manufacturer 
desires to take down wool without substitution he should give the bank the cash value 
of the wool taken, for the bank should be secured either by warehouse receipts or cash all 
the time its acceptance is out.” National City Company, Pamphlet on Acceptances, 
November, 1920, Pp. 4. 


"8 DOMESTIC AND FOREIGN EXCHANGE 


thorized national banks to accept drafts only in connection with the 
financing of foreign trade. It was not until 1916 that that law was 
amended so as to permit national banks to accept drafts arising out 
of domestic transactions. During the last few years, however, the 
laws of the more progressive states have not only greatly widened 
the powers of state banks in this respect, but they have also aided in 
the development of the use of both trade and bankers’ acceptances 
by permitting state banks to invest their funds in such acceptances. 

Until 1921 the open discount market in the United States had not 
progressed sufficiently to take care of the business that was actually 
available, as a consequence of which it was greatly dependent upon 
the Federal Reserve banks. This is clearly evident from the follow- 
ing table showing at various dates the percentage of the total bills 
outstanding which the Federal Reserve banks had to purchase from 
member banks and others unable or unwilling to carry them to ma- 
turity: 


I 2 3 Per Cent of 
Owned by Owned by Estimated Column 2 
Reserve Bank All Reserve Amount to 

Date New York Banks Outstanding Column 3 
Dec. 31, 1916....$ 41,457,000 $127,497,000 $ 250,000,000 51.0 
Decx31,-1007.....1140,1 25,000 | ..275.360,000 450,000,000 Obae 
DECI 21, 101 S.cne 00,321,000 9) 202.072.0000 7 50,000,000 40.5 
Dec. 31, I919.... I01,312,000 585,212,000  ~1,000,000,000 58.5 
Dec. 31, 1920.... 109,902,000 255,702,000 1,000,000,000 26.0 
Mar. 25, 1921... 39,386,000 123,056,000 1,000,000,000 12.9 


The Royal Bank of Canada in a pamphlet issued in 1921 entitled 
“Financing Foreign Trade” (p. 63) states that “..... the open 
market now existing in New York for this class of paper [acceptances] 
is probably second only to that of London.” Nevertheless, our bankers 
and exchange dealers, as well as our business men, still have much 
hesitancy regarding the advantages that would accrue from the use 
of trade and bank acceptances in financing domestic and foreign 
trade. 1 


1For more detailed discussion of trade and bank acceptances, see the annual reports of 
the Federal Reserve Board, the Federal Reserve Bulletin, the publications of the National 
Trade Acceptance Council, and “‘Acceptances, Trade and Bankers,” by P. Mathewson 
(Appleton and Company, New York, 1921). 


CHAPTER IV 
INDORSEMENT, ACCEPTANCE, AND LIABILITY ! 


Before going farther into the subject it is advisable that certain 
matters relating to the acceptance and indorsement of bills of ex- 
change and the liability of the parties concerned be more fully dis- 
cussed, because of their great significance in practically all exchange 
transactions. 

All bills of exchange that are negotiable are made payable either (a) 
to a certain party “or order,” or (b) to “bearer.” In the case of 
“order” bills, the party in whose favor they are drawn, or in the case 
of “bearer” bills, the bearer, may indorse them and pass them to an- 
other party. Bills of exchange brought into existence by a party 
other than the debtor or his creditor, such as bank drafts, express 
and postoffice money orders, etc., are usually drawn payable to the 
creditor or to his order. The debtor purchases such kinds of exchange 
from a bank, postoffice or express company in order to make pay- 
ment to his creditor. In the case of bills drawn by the creditor on 
his debtor or on the latter’s financial agent, the drafts are usually 
made payable to the creditor or to his order, in words similar to the 
following: “Pay to ourselves or order, the sum of, etc., etc.’’ In the 
first case, when the creditor receives the instrument of payment 
through the mails from his debtor he indorses the bill by writing his 
name on the back of the document and hands it to another party, 
receiving his money therefor or asking the other party to collect it 
for him. In the second case, i. e., where the creditor draws the draft 
payable to himself or order and sells it, i. e., discounts it, at the bank, 
he likewise indorses it on the back and receives payment from the 

1 While this chapter deals with certain matters that relate in a way to negotiable instru- 
ments as a whole, I have felt it advisable to confine the discussion solely to matters affecting 
those bills of exchange that are commonly used in domestic and foreign exchange transac- 
tions. It must not be overlooked by the reader that the principal kinds of negotiable in- 
struments are bills of exchange, both domestic and foreign; promissory notes, including 
notes and certificates of deposits; checks or orders by depositors on their banks to pay 
money to a third party, and bonds or promises to pay in a special form by corporations or 


the government. (Cf. Huffcut, E. W., ‘‘The Elements of Business Law, ” 1917 ed., pp. 
159-160.) 


79 


80 DOMESTIC AND FOREIGN EXCHANGE 


bank. If he has drawn the draft on his debtor and has made it pay- 
able to a third party or order, he merely delivers it to the party named 
aS payee, no indorsement being necessary. In case of indorsement, 
the one who indorses is known as the “‘indorser”’ and if when indorsing 
he makes the bill payable to a certain party, that party is known as 
the “indorsee.” If under any circumstances the bill should be made 
payable to “bearer,” it would be possible for the drawer or the holder 
of the bill to deliver it to another party without indorsement, pro- 
vided the other party were willing to accept it without indorsement. 
The party who delivers a negotiable instrument without indorsement, 
i. e., by delivery, is known as the “vendor,” while the person to whom 
he delivers the bill is known as the “vendee.”’ The person who trans- 
fers the instrument to another by indorsement or delivery is also 
known as the “transferor”; the person to whom the instrument is 
transferred is known as the “transferee.” As noted in previous 
chapters, the party who draws the draft is the “drawer’’; the party 
upon whom the draft is drawn is the “drawee”’; the one who pays 
is the “payer,” and the one who is paid is the “payee.” 

According to the Uniform Negotiable Instruments Law, which 
has been adopted with but slight variations by all states except 
Georgia,! a bill of exchange is negotiated when it is transferred from 
one party to another in such a manner as to constitute the transferee 
the holder thereof in due course.” If the instrument has been drawn 
payable to bearer, or indorsed to bearer or “in blank,” it may be 
negotiated merely by delivery, while if it has been drawn payable to a 
certain party or his order it is negotiated by the indorsement of the 
party who legally holds it, followed by its delivery to the transferee. 


INDORSEMENT 


Indorsement is made by the holder of the bill signing his name on 
the back of it, with or without additional words which convey instruc- 


1In the following pages the wording of the Uniform Negotiable Instruments Law has 
been very closely followed. 
2A holder in due course is a holder who has taken the instrument under the following 
conditions: 
“(r1) That it is complete and regular upon its face; 
(2) That he became the holder of it before it was overdue, and without notice that 
it had been previously dishonored, if such was the fact; 
(3) That he took it in good faith and for value; 
“(4) That at the time it was negotiated to him he had no notice of any infirmity in 
the instrument or defect in the title of the person negotiating it.”’ (Uniform 
Negotiable Instruments Law, California Civil Code, Sec. 3133.) 


INDORSEMENT, ACCEPTANCE, AND LIABILITY 81 


tions or qualify his liability. If the bill has been covered with in- 
dorsements a slip of paper, known as an “allonge,” may be pasted 
on its back, on which extra indorsements may be written. 

A commonly accepted rule of law is that a person cannot transfer 
any title or right which he does not possess. There are two general 
exceptions, however, namely, negotiable paper and money. If I lose 
$100 which Smith finds and spends at his grocery store, I have no 
action at law against the grocery store to recover my money. The 
grocery store receives a title or right to the money which Smith did 
not possess. The same exception to the general rule holds true in the 
case of negotiable paper. Suppose that Smith steals from Jones a 
negotiable instrument made payable to bearer and that Smith in- 
dorses it and delivers it to Robinson. If Robinson has received the 
instrument before maturity, for value, in good faith, and without 
knowledge of the defect in Smith’s title to it, Robinson is a “holder 
in due course” and Jones cannot defend himself against payment 
by claiming that Smith got possession of the instrument by fraud or 
without consideration. ‘Thus while Smith’s title would not be good 
as against Jones, Robinson would receive title to it under the cir- 
cumstances stated because the instrument is “negotiable.” 1 As 
Huffcut says: “Negotiability carries with it the following results: 
(a) the transferee gets a legal title and can sue in his own name; (b) 
if the transferee is a holder for value and without notice of defenses 
and obtains title before maturity of the instrument, he is free from 
the defenses that might have been set up against his transferor, ex- 
cept those that operate to destroy the contract altogether. He is not 
subject to the personal defenses of fraud, duress, want of consideration, 
want of title in the transferor and the like, but is subject to the absolute 
defenses of forgery, alteration, infancy of the maker, that the stat- 
ute declares the instrument void (as it does in a gambling contract), 
ete 

If the instrument has been drawn in duplicate or triplicate, the 
indorser must be careful not to indorse the copies to different parties, 
otherwise he will be held liable on each so indorsed. 

Indorsements may be “‘special,” “‘in blank,” “restrictive, 


> 


“ quali- 


1 “A holder in due course holds the instrument free from any defect of title of prior par- 
ties, and free from defenses available to prior parties among themselves, and may enforce 
payment of the instrument for the full amount thereof against all parties liable thereon.” 
(Uniform Negotiable Instruments Law, California Civil Code, Sec. 3138.) 

2 Op. cit., p. 162. 


82 DOMESTIC AND FOREIGN EXCHANGE 


fied,” or “conditional.” A “special” indorsement (sometimes known 
as an indorsement “in full”) specifies the person to whom or to whose 
order the bill is payable, and the indorsement of that person is neces- 
sary to further negotiate the instrument. The following isan example 
of such indorsement: 


Pay to John Jones or order 
Wm. Smith 


In this case the bill could not be passed to another party without the 
indorsement of John Jones. An indorsement “in blank”’ specifies 
no party to whom or to whose order the bill is payable. A bill in- 
dorsed in blank is really payable to bearer and may be negotiated by 
delivery without further indorsement. Such an indorsement is found 
in those cases where the indorser merely signs his name, with no 
qualifying words of any sort. Thus if William Smith above had 
signed his name on the back of a bill of exchange, such an indorsement 
would have been an indorsement “in blank.” Bills that bear a special 
indorsement or an indorsement in blank may be indorsed by the 
holder as he wishes, that is, he may put his indorsement in any form 
that he desires. If a bill has been made payable to himself or order 
(i. e., a special indorsement), he may indorse it in blank, or he may make 
his indorsement restrictive, qualified, or conditional. Also when he 
has been handed a bill which has been indorsed in blank, he may make 
his own indorsement “special,” “qualified, ’ “restrictive,” or “con- 
ditional.” A holder may convert the indorsement in blank of the 
previous holder into a special indorsement by writing over the latter’s 
signature any contract consistent with the character of the indorse- 
ment. Thus, if Wm. Brown desires to protect himself from the risks of 
carrying a check or draft indorsed to him in blank by Andrew White, 
he may write above White’s signature the words, “ Pay to Wm. Brown 
or order.” Bills of exchange, as well as the accompanying documents 
that require indorsement, are frequently indorsed “in blank.” 

An indorsement is restrictive when it limits further negotiation, or 
constitutes the indorsee the agent of the indorser, or vests the title 
in the indorsee in trust for or to the use of some other person. Thus, 
“Pay to John Jones only” is a restrictive indorsement and prevents 
further negotiation. But “Pay to John Jones,” the word “only” 
being omitted, is not a restrictive but a special indorsement. “Pay 
to John Jones or order for collection for my account,” or “Pay to 


INDORSEMENT, ACCEPTANCE, AND LIABILITY 83 


the First State Bank for the benefit of John Jones,” are also forms 
of restrictive indorsement. Such form of indorsement confers upon 
the indorsee the right to receive payment of the bill, to bring any 
action in connection with the same that the indorser could bring, or 
to transfer his rights as such indorsee when the form of the indorse- 
ment authorizes him to do so, but all later indorsers acquire only the 
rights and title of the first indorsee under the restrictive indorsement. 
Another form of a restrictive indorsement is found in what is called 
a “Restricted in trust indorsement,” such as “Pay to the First Na- 
tional Bank for account of William Smith.”? Such indorsement passes 
title to the bank for the benefit of William Smith, and is the form 
used when a deposit is made for the account of one who cannot make 
proper indorsement in person because of absence, age, incompetence, 
iG: 

A qualified indorsement is one which is made by adding to the in- 
dorser’s signature the words “without recourse” or words to the same 
effect. Such an indorsement does not guarantee the payment of the 
bill nor does it impair its negotiability. It merely limits the liability 
of the indorser who under such circumstances becomes what is techni- 
cally known as an assignor, whose liability will be more fully discussed 
later. 

A conditional indorsement is one where some condition is added to 
the indorsement, such as “Pay to John Jones or order on the com- 
pletion of his contract to build my house.” If such a condition had 
appeared in the body of the bill itself it would have made the bill non- 
negotiable, because the date of payment is not “determinable,” but 
its appearance as part of the indorsement has no such effect. Any 
bill that is originally negotiable continues to be negotiable until it 
is restrictively indorsed or discharged by payment or otherwise. 
Only a restrictive indorsement nullifies the negotiability of a bill 
that has previously been negotiable. 

At times an indorsement is used waiving the right to be notified in 
case the instrument is protested either for non-acceptance or for non- 
payment. An indorsement “waiving protest”? would be as follows: 


Protest and notice of protest waived 
John Jones 


Such an indorsement, however, does not relieve the indorser from any 
liability to the holder of the bill. It merely notifies the holder that 


84 DOMESTIC AND FOREIGN EXCHANGE 


the indorser will consider himself liable as an indorser without the 
necessity of being notified that the bill has been protested.1 Some 
banks consider such an indorsement as being merely a waiver of 
the indorser’s right to be notified in case of protest and require 
the indorser to indorse in blank before he indorses “waiving pro- 
Leste 


ACCEPTANCES 


Indorsements always appear on the back of a bill of exchange. An 
acceptance, however, usually appears on the face of the bill, never 
on the back, written either directly or diagonally across the bill. In 
England the acceptance has to be on the bill itself but in the United 
States it may be made on a separate sheet. The customary form of 
acceptance is made by writing the word “Accepted,” the date and 
the acceptor’s name on the face of the bill, although the date and the 
acceptor’s signature alone are sufficient without the use of the word 
“Accepted.” Under the Uniform Negotiable Instruments Law, the 
holder of a bill may require that the acceptance be written on the face 
of the bill itself and if his request is refused he then has the right to 
treat the bill as dishonored. However, if he consents, the acceptance 
may be written on a piece of paper other than the bill itself, but in 
such cases the acceptor is bound only to the person to whom it is 
shown and who, on faith, receives the bill as an accepted document. 
An unconditional promise to accept the bill, given even before the 
bill has been drawn, is deemed to be an actual acceptance. Bills 
drawn payable at sight are presented for payment only. Bills drawn 
payable a certain number of days from sight must be presented for 
acceptance and run the designated number of days following the 
presentment for acceptance. Bills drawn payable a certain number 
of days from date run from the date the bill is drawn, and may be 
presented for acceptance at any time or not at all. The drawee has 
twenty-four hours after the bill is presented to him in which to accept, 
but the date of the acceptance is as of the day of presentation. If he 
destroys the bill or refuses to return it to the presenter within the 
twenty-four hour limit, or within any period that the presenter or 
holder may allow, he is deemed to have accepted the bill. 

An acceptance is merely the act of acknowledging in writing that 


1 The process of protesting and the liability of the parties concerned will be discussed 
in a later portion of this chapter. Cf. pp. 88-90. 


INDORSEMENT, ACCEPTANCE, AND LIABILITY 85 


the obligation or debt is honored and will be paid at maturity. The 
word “‘acceptance” is also used as referring to the instrument after 
it has been accepted, as well as to the words that constitute the 
acknowledgment. Ifadraft has been drawn in duplicate or triplicate, 
the drawee should accept but one copy. If he places his acceptance 
on more than one copy, and if the copies have by chance been indorsed 
to different parties, the acceptor becomes liable on each such accept- 
ance. 

According to the Uniform Negotiable Instruments Law an accept- 
ance (the act of accepting) may be either general or qualified. A 
general acceptance acknowledges the obligation without any qualifi- 
cation whatsoever. The usual form is as follows: 


Jani 1921 
Accepted 
John Jones 


It is also possible to designate the place at which the instrument is to 
be paid, as: 


Jan. 1, 1921 

Accepted 

Payable at the First National Bank, 
Berkeley, Cal. 

John Jones ! 


On the other hand, a qualified acceptance varies the effect of the bill 
in some particular. It may be conditional, partial, local, qualified 
as to time, or it may be the acceptance of one, or some, but not 
all of the drawees. A conditional acceptance imposes certain con- 
ditions which must be met before the bill will be paid, such as the 
following: 

Jan. I, 1921 

Accepted provided shipping documents 

are turned over to me 
John Jones 


A qualified acceptance may be “partial,” i. e., be an acceptance of 
only a part of the face value of the bill. Thus if the draft has been 


1 Cf. footnote p. 69 as to the legal interpretation of this kind of acceptance. 


86 DOMESTIC AND FOREIGN EXCHANGE 


drawn for $1,000 and the drawee accepts for only $800, such an ac- 
ceptance would be “partial.” If the acceptance designates the place 
at which and only at which the bill will be paid, it is a “local accept- 
ance.” 


Jan. 1, 1921 

Accepted 

Payable only at the First National Bank, 
San Francisco, Cal. 

John Jones 


If the draft is drawn payable at sixty days sight, and the drawee 
accepts but makes the bill payable at a shorter or longer length of 
time, then the acceptance is qualified “as to time.” It is not unusual 
to have a draft drawn against two or more parties. Ii all of the parties 
do not accept the draft when presented to them, the acceptance is 
“qualified.” The holder of a draft may refuse to receive a qualified 
acceptance and may proceed to have the bill protested if he wishes 
to do so. Where the holder consents to a qualified acceptance he 
releases the drawer and the indorsers of the bill unless they have ex- 
pressly or impliedly authorized him to take such an acceptance. If 
the holder notifies the drawer and the indorsers that he has seen fit 
to take a qualified acceptance, they must individually notify him of 
their dissent within a reasonable time, otherwise they will be deemed 
to have given their consent to the same. : 
There is also an ‘“‘acceptance for honor.”” This occurs where a bill 
of exchange that is not overdue has been protested for non-acceptance 
or for better security, and some party, other than a person already 
liable on the bill, intervenes and accepts the bill “supra protest”’ 
for the honor of any party liable on the bill. He may accept for the 
honor of any one of the parties already liable as drawer or indorser, 
or for the honor of the drawee himself.’ In his acceptance he mentions 
the party for whose honor he is accepting. The bill under such cir- 
1In foreign exchange transactions it is not unusual for the drawer to realize that diffi- 
culty may be met in connection with the matter of acceptance or payment. To avoid 
delays, loss of interest, etc., he will therefore designate some party in the town of the drawee 
to whom the holder of the bill may have recourse in such a case. He will designate such a 
party on the face of the bill or on the instructions that accompany the bill. In case the 
drawee refuses to accept or to pay, the holder then goes to this party, who is known as a 
“‘referee in case of need,” who in his turn may accept the bill for the honor of the drawer, 


or who may serve in other ways as the agent of the drawer so as to save the latter any 
unnecessary expense. 


INDORSEMENT, ACCEPTANCE, AND LIABILITY 87 


cumstances runs from the date of presentment to and non-acceptance 
by the drawee, and not from the date upon which it is accepted for 
honor. The acceptor for honor agrees to pay the bill at maturity 
provided that at its maturity it is presented to the drawee for pay- 
ment, refused payment, i. e., dishonored, formally protested for non- 
payment, and a formal notice of such dishonor given to him (the ac- 
ceptor for honor). Payment for honor must be made before a notary 
and attested by him, the attest to be appended to the “protest ”’ 
or made an extension of it.! 

Crossed Checks. In handling sterling exchange one frequently runs 
across an interesting practice found only in England known as “cross- 





Crossed check 


ing” a check. A crossed sterling check is one that is madé payable 
to bearer or order which has the name of a banker or two parallel 
lines and the abbreviation “and Co.” written or printed across its 
face. (Fig. 24.) The effect is to direct the bank upon which the check 
has been drawn to pay it only when it is presented by some other bank. 
The purpose of crossing a check is to provide an additional safeguard 
against wrong payment. Under the English Bills of Exchange Act 
of 1906, a crossed check can only be credited to a customer’s account 
or paid to another banker. Itcannot be paid incash to the 
customer. 


1 Cf. p. gt. 


88 DOMESTIC AND FOREIGN EXCHANGE 


LIABILITY OF PARTIES ! 


In discussing the liability of the parties who are interested in the 
kinds of negotiable instruments with which this volume deals, it is 
necessary to distinguish between parties primarily or unconditionally 
liable and those secondarily or conditionally liable. The Uniform 
Negotiable Instruments Law declares that “The person ‘primarily’ 
liable on an instrument is the person who by the terms of the instru- 
ment is absolutely required to pay the same. All other parties are 
‘secondarily’ liable.” It has often and incorrectly been said that 
the drawer of a bill is primarily liable, that he is “absolutely required 
to pay the same,” but according to the terms of the Uniform Negotiable 
Instruments Law he is not bound to pay unless the bill has been pre- 
sented to the drawee for acceptance or payment, as the case may be, 
and has been dishonored by the latter, following which due notice 
of such dishonor has been sent to him (the drawer). Unless these 
three things, i. e., proper presentment, dishonor, and notice of such 
dishonor, have been done in accordance with the terms of the law 
it is not possible to hold the drawer liable. Even an acceptor “for 
honor,” as has been noted above, is not liable as an acceptor unless 
the bill has been presented for payment to the drawee, dishonored, 
protested, and a notice of such protest sent to him (the acceptor “for 
honor ”’). It should also be made clear that the drawee is not liable 
in connection with a bill of exchange before he has accepted it even 
though he legally owes the drawer the sum of money in question. A 
written promise to accept, appearing on a separate piece of paper, 
given even before the bill has been drawn, is looked upon by the courts 
as a regular acceptance, even though the drawee when the draft is 
presented to him for acceptance refuses to place his acceptance on 
the face of the bill. After the drawee has accepted the bill he is the 
only person primarily liable and absolutely bound to pay the same 
when presented to him for payment at maturity. The situation is 
the same as though the acceptor were the maker of a promissory note 
and the drawer were the first indorser thereof. The drawer and the 
various parties who indorse either before or after the acceptance of 
the bill, together with the acceptor for honor, are liable only when 
the bill has been presented for payment, dishonored, and a notice 
of such dishonor (or protest) sent them. Consequently they (the 


1 See Whitaker, of. cit., pp. 29-38, for an excellent discussion of this matter. 


INDORSEMENT, ACCEPTANCE, AND LIABILITY 89 


drawer, the indorsers, and the acceptor for honor) are secondarily 
liable, that is, liable on condition that a certain legal procedure is 
followed for the purpose of holding them liable before the law. 

Presentment for acceptance must be made to the drawee, while 
presentment for payment at the maturity of a bill must be made to 
the “acceptor.” Presentment, either for payment or for acceptance, 
must be made by the holder of the bill at a reasonable hour of the 
business day and at a proper place, otherwise the drawer and the in- 
dorsers will be discharged from their liability. When the place is 
specified in the bill itself presentment must be there made. For ex- 
ample, if the drawee’s acceptance has stated that the bill is to be paid 
at a designated bank or address, presentment must be made accord- 
ingly. If no place is designated, then it must be made at the place of 
business of the drawee or at his residence. Presentment for payment 
must be made upon the date of the maturity of the bill, although in 
some states and in some European countries the payer is allowed a 
few days extra (days of grace) after the presentment of the bill in 
which to arrange for payment. In the United States and in European 
countries days of grace are not allowed as arule.! Great Britain, how- 
ever, permits three days of grace; Canada does likewise. Among 
South American countries days of grace vary from six to fifteen. If 
the bill is payable at sight there is no need of acceptance because it 
must be paid at once inasmuch as days of grace do not ordinarily run 
in the case of such bills. 

If the drawee refuses to pay a sight bill upon presentment it must 
be protested at once. If the bill has been accepted and at maturity 
the drawee refuses to pay, then after the allowable days of grace have 
run, and payment is still not forthcoming, the bill must be protested. 
Protesting arises only in case of failure to accept or failure to pay and 
is made for the purpose of protecting the interests of the holder of 
the bill by taking certain required legal steps which are necessary in 
order to hold the drawer and the indorsers liable for payment. Failure 
to protest, however, does not free from liability the party or parties 
primarily liable. When the drawer draws the draft he, according to 
the law, agrees to pay the amount thereof to the holder or to any 
subsequent indorser who may be legally compelled to pay it, provided 
presentment, dishonor, and notice of dishonor take place. The 


1 Huffcut, op. cit., p. 162, states that days of grace are allowed in Mississippi, Texas and 
Wyoming on all classes of bills; in Massachusetts and North Carolina on sight bills only, 
and in Alaska only on paper payable at a future date. 


go DOMESTIC AND FOREIGN EXCHANGE 


drawer, however, may insert a stipulation in the bill negativing or 
limiting his own liability to the holder. Unless such stipulation is 
inserted the liability of the drawer ceases only with the payment 
of the bill, not with its acceptance. When the drawee accepts the bill 
he agrees to pay at maturity. An acceptor for honor agrees to pay 
at maturity provided pre entment to drawee, dishonor, and notice 
of dishonor take place. When a party indorses a draft, either before 
or after it has been accepted, he agrees to pay the instrument pro- 
vided it is not paid by other parties who are liable and also provided 
presentment, dishonor, and notice of dishonor occur. Notice of such 
protest must be sent to all those who have not by their indorsement 
waived the right of demanding such notice by indorsing “Protest 
and notice of protest waived” or words to a similar effect. Any 
party negotiating a bill merely by delivery or by qualified indorse- 
ment warrants that the instrument is genuine and that it is in all 
respects what it purports to be, that he has good title to it, that all 
prior parties had capacity to contract, and that he has no knowledge 
of any fact that would in any way impair the validity of the bill or 
render it worthless. In other words, the liability of such a party is 
merely that of a seller. His guaranties or warranties extend only 
in favor of the immediate transferee, i. e., the person to whom the 
instrument is passed by him, and not to subsequent holders of the bill. 

Protest is necessary only in the case of “‘foreign”’ bills, i. e., those 
that have been drawn upon a party residing in another state or country, 
but is not required where the bill has been drawn in one state and 
made payable by a party in that state. Protest is usually made by a 
notary public, although it may be made by any respectable person 
in the presence of two or more creditable witnesses. It must be made 
on the day the bill has been dishonored, unless delay be excused, and 
must be made at the place where it has been dishonored. The protest 
blank or document is a formal notice which is either appended or 
attached to the bill itself, specifying the time and place of present- 
ment, stating that the bill has been dishonored by non-acceptance 
or by non-payment, and that the parties concerned, mentioned by 
name, are therewith notified of such dishonor and will be held liable 
in their respective capacities (Fig. 25). When a bill has been handed 
to a notary for protest, he presents it to the drawee for acceptance or 
for payment as the case may be, and upon the refusal of the latter to 
accept or pay, makes a notation to that effect in his protest book. 


This is called a “no- 
tation of protest.” 
He must thereupon 
promptly notify the 
drawer and indorsers 
of such dishonor or 
the holder will lose 
his legal claim against 
them. If possible 
protest notices (Fig. 
26) must be presented 
in person to the 
parties concerned, 
but if such cannot 
be done, they may 
be mailed by deposit- 
ing them in the post- 
office, in a branch of 
the postoffice, or in a 
letter box under the 
control of the post- 
office department. 
Mailing must take 
place on the day fol- 
lowing the day of 
protest, or, if there is 
no mail service at 
that time, then on 
the first mail there- 
after. Notice is 
deemed to have been 
given even though 
there is a miscarriage 
of the mails. If the 
notary does not have 
the addresses of all 
the indorsers and the 
drawer, he need only 
send the notices of 


Cowttery® Poco Nu. $6 I RIT ESTE { octncd 


2 nabice. of. 


by depositing the same mr Ye O 
County of... j 
a ae loren: directed as ttoied t their last Kncwon ple of realenct pepe coesonueneinee 











DOMESTIC EXCHANGE gt 





Wnited States of America, | 





State of baiifarnie: Se 58, 
County of. Asemene : 


By this Public eetennent of Pirntest, 


~ Be it Kut, that on the f3urth doy of. T2AVALY 


- ORE thoumnd nine hundred ond trent: gotro a the request oj 


SON AQ Anderson. 
i, Wo Be Carlran 
and. sudan, dwelling in thy satd Coney of © ae ‘ : lid 
durwig the businesa hours of noid day present the eet sratk 
{a oOpy of which os endorsed, vt the foot of this sheet) to. the Firat Harionar Bank 


-y @ Notary Public, duly commissioned 


‘ af Barkeloy, Cabifornia 


Wherein, ESBS earisens secs the pan Neary Public, 
at the request of mie did PROTEST, and by these presents do publicly PROTEST. 


as well against the. TAKSY nnd endorsers 


ux againet alt others when it dovs or may concern, for exchange, resechange and all coats, 
oo charges and interest already incurred, and ty be hereafter. incurred, far the 
Hour avoes : ne af the wai 
. drat. sere 
Thus Bane and Pratesten, an the aaid Coane of Alamestia 
the day and year ubove soritien, : 
Hida Hereby Certify, dot on the Fourthday of January... Ih. 
notice of protest, demand and 23b- prsnent ; 
: é -.. Of the above mentioned aratt 
wig scrred by me upon Ur. oiliisn Smith (drawer! , 1ae5 vidorado Street. 
> Bexkealey,.california and th. Jeo Andrews, {endorser}: 381 
“Men Kees Street, Berkeley, California. 












od DNurther certify that an the _ day of oe pcs: 
teh demand und nen-payment of the shave : 
was served by te tepon 


ited States Dost office in the Oe eRe cceameneae 
State of... : 2) postage 





auch betny the re ‘ported places of reridence of Word radpective parties and the post offices nearest 
“s therel, according to the beat information f ead abthgn. 3 


Bn Testinony Whervaf, ¢ here hercuns signed my nome and 
ajjired my Official Seat, tix. 
day vj. 


one Heeresanl! nine unten (he ae 





‘Froure 2 eR blank 


Q2 DOMESTIC AND FOREIGN EXCHANGE 


protest to the party from whom he received the bill, and this party 
to protect himself forwards them to the prior indorser, and so on, 
until all have been properly notified. 

The protest fees of the notary public vary from place to place, and 
are usually fixed by the notaries themselves." The fee is added to the 
amount of the draft and has to be paid by the party who is finally 
liable. 

The notice of protest is merely a legal notification that the bill in 
question has been dishonored and that the indorsers and drawer are 


Notice of Protest 


Sir — Jenuary 4 1922 


Please take notice that a certain draft 


dated December 12. 1921 
for the sum of five thousand dollars ($5,000) 


payable at Finst National Bank of Berkeley. California 

drawn by you tn favor of John Jones 

was this day presented by me ‘to the above bank 

and peyment thereof demanded, which was refused, 
and the said draft having been dishonored, the same was 
this day protested by me for non- payment 

thereof, and the holder looks to you for the payment of the same, together with all 
cost, charges, interest, expenses, and damages already accrued, or that may hereafter accrue 
thereon, by reason of: the non- payment of said draft 


Very respectfully, 
- (MEN 
To___Mr. William Smith gece 
Ni nb! 
Berkeley, California men : 


Tx. and for said ________County of. 





FIGURE 26 
Notice of protest 


to be held liable for its payment. Indorsers are liable in the order of 
their indorsement. To get his money out of the bill the holder may 
sue any one of the indorsers that he chooses, but a suit against any 
indorser frees all subsequent or later indorsers. The indorser who 
has been sued and has paid may in his turn sue the drawer or any of 
the prior indorsers. An acceptor for honor is liable to the holder of 
the bill and to all parties to the bill subsequent to the party for whose 
1 They range from $1.25 to $7.50. 


INDORSEMENT, ACCEPTANCE, AND LIABILITY 93 


honor he has accepted. When a bill which has been accepted for honor 
has been paid, all parties subsequent to the party for whose honor the 
bill was accepted and was paid are discharged. 

When a bill which has been accepted by the drawee is presented 
for payment and is dishonored and then protested for non-payment, 
any person may intervene and pay the bill for the honor of any person 
liable thereon or for the honor of the person for whose account it was 
drawn. ‘This is called “payment for honor supra protest.” Such 
payment must be attested by a notary public and the attest appended 
to the instrument or made a part of it. The attest must contain the 
name of the party for whose honor the payment is made. Payment 
for honor frees all parties subsequent to the party for whose honor the 
bill has been paid, and gives the payer for honor all the rights and 
duties of that party for whose honor he has paid the bill. He can, 
therefore, proceed to collect from any indorser prior to the party for 
whose honor he has paid the bill, or from the drawer. 


CHAPTER V 
EXCHANGE DEALERS 
A. IN THE UNITED STATES 


The exchange market in the United States is unlike the stock and 
produce markets in that the exchange dealers of a city are not or- 
ganized into a central trading body like a Stock Exchange or a Board 
of Trade. The exchange market is what is generally known as an 
“open” market. There is no designated place or time at which buyers 
and sellers come together for trading purposes, and there are no sets 
of rules and regulations by which the dealers abide. During the 
so-called Greenback period (1862-1878), when our nation had sus- 
pended specie payments, gold was bought and sold on the New York 
Stock Exchange because of the fluctuating premium which it com- 
manded. During the World War when the price of silver was changing 
daily, almost hourly, it also was quoted on the Exchange. In 1921 it 
was proposed that foreign exchange should be dealt in on the floor of 
the New York Stock Exchange, following the example of some of the 
European stock exchanges, but thus far (April, 1922), no action 
thereon has been taken by the committee to which it was referred.! 
All transactions in exchange are carried on “over the counter” di- 
rectly between buyer and seller or thru exchange brokers. The 
market is ‘“‘open” and any person who wishes may enter for trading 
purposes. In London until 1920, the situation was slightly different,” 
but even there the market is now an ‘‘open” one. 

The metropolis of a country is usually the center of the exchange 
activities for that country—London for England, Paris for France, 
Berlin for Germany, etc. In the United States, New York is the center 
for all the exchanges, European, South American, and Oriental. 


1 Some of the American writers follow Escher (“‘Foreign Exchange Explained,” p. 54), in 
stating that ‘‘ Years ago bills of exchange were traded in on the New York Stock Exchange.” 
I have carefully checked this matter through various channels, especially through the 
Secretary of the New York Stock Exchange, who very kindly interviewed some of the oldest 
members about it, but nowhere have I been able to verify the statement as made. 

2 See pp. 105-107. 


94. 


EXCHANGE DEALERS 95 


Chicago, New Orleans, San Francisco, and other large cities transact a 
great deal of foreign exchange business, but for the most part it is not 
of an independent character, all of the markets in the United States 
being dependent primarily upon the New York market. A large share 
of the bills purchased from exporters by banks in cities outside of 
New York is handled through New York, and the greater part of the 
bills that are sold by them are also drawn upon banks and financial 
houses in the latter city. Dealers in all parts of the nation make the 
rates for the day almost solely on the basis of the quotations received 
from New York. Even in the matter of rates on the Orient, San 
Francisco does not independently arrive at its own quotations but 
bases them upon telegraphic advices from New York. 

In the foreign exchange market, there is a variety of dealers, just as 
is the case in the produce or clothing or hardware markets. It may not 
be amiss to warn the student of the exchanges that bills of exchange, 
both domestic and foreign, so far as the marketing of them is con- 
cerned, are very much like any other commodity. Those who are con- 
cerned with them may be roughly grouped into buyers and sellers, or 
again into manufacturers, wholesalers, jobbers, brokers, retailers, and 
customers. A party may be in the market both asa buyer and a seller 
at the same time. He may be buying the same sort of exchange that 
he is selling or he may be buying a kind of exchange that he may need 
a few hours or a few months later. He may also be a wholesaler and 
retailer, or a jobber and retailer, at the same time. This analogy will 
be made a little clearer as the discussion proceeds. 

First of all, we have the very prominent banking and financial 
houses of New York, including the head office of the American Express 
Company,! which are vitally interested in practically every phase of 


1 The wide range of activities of some of the large New York houses is surprising. The 
American Express Company, for instance, advises the public that it offers the following 
services: 

“For the importer, the American Express Company: locates foreign dealers in the com- 
modity desired, or sources of raw material; obtains prices and credit report; procures samples 
for examination; arranges a proper introduction between the foreign dealer and the Amer- 
ican purchaser; executes buying orders for account of accredited importers; insures and 
ships the goods, advising as to freight rates and steamship routes and sailings; finances 
the shipment completely; arranges for clearance at the seaboard or ships the goods in bond; 
warehouses or forwards the shipment wherever desired; makes arrangements with the for- 
eign dealer for payment by cable transfer, foreign draft, commercial letter of credit, ac- 
ceptance credit, collection of draft or invoice, or any other approved banking method pre- 
ferred by the importer. Other incidental services of the American Express organization 
are at the disposal of the importer as occasion may arise. 

“For the exporter, the American Express Company: locates the names of foreign pros- 
pects; reports on their financial standing and responsibility; reports on conditions of foreign 


96 DOMESTIC AND FOREIGN EXCHANGE 


the exchange field, both domestic and foreign. These five or ten 
prominent dealers are in the market every day as buyers and sellers 
of large amounts of exchange, their daily transactions reaching into 
the millions of dollars. These concerns have accounts with corre- 
spondents in the more important cities of the world and some have 
two or more correspondents in each of the financial centers of Europe, 
as well as one or more correspondents in every large city in the United 
States. Within the last decade or so several of these dealers have 
established their own branches in London, on the continent, and in 
the Orient. Other cities like Chicago, New Orleans, Boston, San 
Francisco, support three or more large dealers, but none so important 
as those of New York, who likewise have their accounts and corre- 
spondents abroad although not to the same extent as do the leading 
New York houses. 

This first group of dealers carry on an ordinary retail business in the 
sale of exchange in small amounts to their customers over the counter. 
They also do a wholesale business in that they sell millions of dollars 
worth of exchange to other banks or to importing firms which have 
to meet their commitments abroad. They buy equally large amounts 
from exporters and from banks and dealers. They also do what might 
be termed a jobbing business. They stand ready to take care of the 
requirements of their domestic correspondents for such exchange as 
may be requested by the latter or their clients. They are in close touch 
with a large number of smaller dealers scattered all over the country 
who buy and sell exchange through them. As has been stated in 
Chapter II, banks in small towns, and also frequently banks in large 
cities, have no accounts or correspondents abroad, yet their customers 
continually demand exchange or have exchange to sell. The needs of 
the customers must be taken care of, so these banks make arrange- 
ments with the larger dealers whereby they are able to sell exchange 


markets as to demand, competition, prices and other details; advises about the better mar- 
kets as conditions vary; provides direct introductions and references for prospective cus- 
tomers abroad; recommends as to packing, marking, invoicing and shipping; advises as 
to steamship lines and freight rates; offers assistance in dealing with foreign languages, 
weights and measures, currency and foreign exchange, postal requirements and similar 
local problems; explains unfamiliar technicalities; establishes credit anywhere, provides a 
Commercial Letter of Credit, or arranges a foreign checking account, or any other approved 
or preferred banking accommodations; receives the shipment in the United States for export; 
insures and ships the goods by the most advantageous route; finances the shipment while 
in transit; arranges for customs house clearances, domestic and foreign; sees the goods 
delivered to the buyer abroad, or, if desired, warehoused or reshipped; even sells the goods 
on the shipper’s order, if necessary; and finally, handles collections completely, not only 
of current accounts but of old accounts as well, making returns to the shipper.” 


EXCHANGE DEALERS 94 


on foreign countries, or to buy the exchange offered by their cus- 
tomers. The larger banks furnish the needed forms or blanks to the 
smaller institutions and advise them, either daily or weekly, as to the 
rates at which and for what amounts the latter may draw, and also 
as to the rates at which the larger banks will purchase exchange from 
them. 

Many of the banks in Chicago, New Orleans, San Francisco, etc., 
which have a few accounts abroad, would not be able to traffic in 
bills of exchange except on the few countries in which they happen 
to have their own foreign accounts, unless they, too, made arrange- 
ments with the large New York houses similar to those described 
above in the case of small town bankers. This group of banks in 
their turn, as has been noted in Chapter II, may likewise become 
jobbers in exchange, selling to a large list of small correspondent banks 
in their individual territory, handling the business through their own 
foreign accounts or through the larger New York banks. 

A number of foreign banks have branches in the more important 
cities of the United States. These branches conduct a general business 
in foreign exchange and also act as agents through which American 
banks may purchase or sell exchange on foreign countries. 

The exchange dealers have no outside men, i. e., no employés that 
go from bank to bank or from firm to firm, buying and selling exchange. 
Their business is transacted over the counter, by mail, by telegraph, 
or by telephone. They are constantly in touch with the exchange 
developments in the more important financial cities of the world. 

The next class of exchange dealers is composed of the small banks 
above mentioned, which have no foreign accounts abroad but which 
are able through their connections with the larger banks to supply 
the needs of their customers who desire exchange accommodations. 
As a rule, they are able to sell only ordinary sight drafts on foreign 
countries and then only for relatively small amounts, unless special 
permission be obtained from the jobbing bank. Generally they have 
authority to sell only on the more important European, South Ameri- 
can, and Oriental cities. If their customers require traveler’s letters 
of credit, import or export credit, or some more technical form of 
exchange, the small local bank cannot provide it, and will have to 
act merely as an agent in getting it for the customer from the jobbing 


1 The details of the work of the foreign exchange department of a bank will be more 
fully discussed in subsequent chapters. 


98 DOMESTIC AND FOREIGN EXCHANGE 


bank. Jobbing banks usually grant the right to be drawn against 
only for a certain length of time, commonly for not more than a year. 
In such cases, the arrangement has to be renewed annually and the 
amount set for which the small bank may draw. These smaller banks 
make a practice of engaging in the exchange business only for the 
purpose of taking care of the immediate needs of their depositors. 
Ordinarily they do not buy exchange from their customers, but act 
only as agents in forwarding it to the larger banks. Their exchange 
business is of the regular routine character and requires no special ° 
knowledge of the principles or theories of exchange. They receive 
their rates daily or weekly from the jobber, add their profit, and 
charge the customer the resulting amount. They then remit to the 
jobbing bank at the rate quoted by the latter. They care nothing as 
to the forces that move the exchange market or as to its more technical 
or theoretical phases. 

The next class of firms in the exchange market is technically known 
as the “dealers.”” As American foreign commerce has developed, an 
increasingly large number of bills has come into the market. Many 
of these bills have been drawn by exporting firms in cities far removed 
from New York, which, realizing the importance of the New York 
market and the fact that they can possibly get a much better rate for 
their bills in that city than in their home towns, regularly send them 
to that center to be marketed. They have no banking connections in 
New York, and consequently make arrangements with exchange 
dealers to handle the bills for them. These dealers are usually small 
firms made up of men who are experts in the exchange business. When 
the bills are drawn by the exporter they are mailed to the dealer, who 
takes them from bank to bank and markets them at the best obtain- 
able price. Or it may be that the exporting firm has agreed to sell 
certain goods to some foreign company at a future date, say three 
months hence. It therefore instructs its New York dealer to get for 
it the best possible contract price or rate for the bills which it will have 
for sale three months hence. The dealer therefore goes from bank 
to bank and secures the best offer that he can for this “future.” + It 
is possible for the dealer to act as an agent for scores of firms scattered 
throughout the country. All sorts of bills may be sent to him by his 
clients to be disposed of in the New York market. He may personally 
make the rounds of the exchange houses each day, or he may transact 


1 Cf. pp. 497-501. 


EXCHANGE DEALERS 99 


a great deal of his business over the phone. As he usually has a variety 
of bills in his portfolio, he is a welcome visitor at the bank’s counter. 
Each bank is thus enabled to purchase the kind and the amount of 
exchange that it wants and to keep its foreign accounts in the desired 
condition. The dealer may also have orders to buy exchange and here 
again he is able to obtain for his out-of-town clients much better rates 
than they could get from their local banks. As a rule, the rates in 
New York vary little from bank to bank, sometimes not at all, but, 
no matter what the case may be, it is the task of the dealer to take 
the best possible care of the interests of his clients. At times the 
dealer may actually have foreign accounts himself, and buy from 
or sell to his clients just as banks do, but that is not usually the case. 
The dealer charges his clients a small commission, but his charges are 
more than offset by the better rates which he obtains for them. In ad- 
dition to acting for a large number of clients who are either export- 
ers or importers, he also frequently acts as the New York represent- 
ative of a number of the larger banks in other parts of the country in 
connection with their purchases and sales of foreign exchange. Often 
they commission him to keep them advised as to the fluctuations in 
the exchange rates, and he accordingly wires them at the opening of 
the day the sight rates for the more important European exchanges. 
If during the day the rates change noticeably, he immediately wires 
his client banks to that effect. A client bank in Chicago may find 
that it needs a certain amount of exchange on London to take care of 
its obligations; it wires him to purchase the same for its account; or 
a San Francisco bank may happen to have more franc exchange on 
hand than it needs and it wires him to dispose of it at the best price. 
By this means the exchange of the client bank is sold or purchased 
at much better rates than it itself could secure by trying to sell to or to 
purchase from some bank in its own community. 

With the exception of the above paragraph, the word “dealer”’ 
will not be used in this volume in its technical sense. In subsequent 
pages, as has been true of the earlier ones, the word will be used as 
referring to all firms, banks, trust companies, financial houses, ex- 
press companies, etc., which deal in the exchanges. ? 

Among some exchange men and also in the literature on the subject 
the “dealers” as described above are sometimes known as “brokers.” 
To be strictly technical, however, the broker is a different type of dealer. 
He is a man, usually without an office, who comes between the buyer 


100 DOMESTIC AND FOREIGN EXCHANGE 


and the seller. As a rule, he trades solely with the larger exchange 
dealers. Each morning he goes from bank to bank, asking what they 
have to sell or what they wish to buy, getting their bids and their 
offerings and very carefully inquiring as to their rates. He may find 
that one bank wishes to sell some sterling exchange at a slightly lower 
rate than some other bank is willing to pay. He acts as the go-between 
in making the transaction and his profit may either be the difference 
between the purchase price of the one bank and the sale price of the 
other, or it may be that he receives a commission. A bank may be 
in the market for exchange on some particular center, and may give 
him an order to get it at the best possible price. In that case, the 
broker gets only a commission for his work. Before the wide use of 
the telephone, the broker was a very useful and necessary person in 
buying what some banks desired and in selling what other banks wished 
to get rid of. Today his lot is far from an easy one, because the banks 
themselves for the most part take care of their needs over the tele- 
phone. Before the introduction of the Gold Settlement Fund of the 
Federal Reserve System the broker was very active in the sale of 
domestic exchange. But, as noted earlier, that field has been almost 
completely taken away from him. On foreign deals, the competition 
among brokers themselves has greatly reduced the commissions. 
Formerly the average charge was a commission of 1/20 of 1 per cent 
on the pound sterling, or $5.00 on every £10,000, and about 1/64 of 
I per cent on Continental exchanges, or on francs, for example, $3.00 
on a turnover of 100,000 francs. Since the World War these rates 
have declined to about 1/16 to 1/8 of a cent per £, and to about one 
point on Continental exchanges, except on marks, where the average 
rate is about 1/4 to 1/2 of a point. 

Lately there has arisen in the United States a new group of ex- 
change dealers, viz., the acceptance houses. This innovation has 
been made possible through the changes already referred to, resulting 
in the development of our acceptance market. During the last few 
years the practice of using the acceptance for both domestic and foreign 
trade has grown to such an extent as to warrant the establishment 
of several acceptance houses with headquarters in New York, Boston 
and other eastern cities. Their primary function is to buy and sell 
acceptances, i. e., to discount (buy them) at one rate and to sell at 
another thus making a slight profit. They issue circulars to clients 
scattered all over the United States telling what acceptances they 


ie] 


EXCHANGE DEALERS 


Ior 


have for sale, what the accepting bank is and where located, the 
amount of the acceptance, the length of time it has to run, and the 


rate at which it is for sale (Fig. 27). 


JONES SMITH AND COMPANY 
85 Wall Street 


Dear Sirs: 


New York City 
May 17, 1922 


We own and take pleasure in offering subject to prior sale and change 
in rate all or part of the following acceptances for delivery in New York. 


Amount Acceptor 


$300,000 Chase National Bank New York 
200,000 Guaranty Trust Co. 
50,000 Huth & Company 
100,000 Bank of New York N. B. A. fe 
150,000 BrownBrothers & Co. 
200,000 Central Union Trust Co. 
150,000 Chase National Bank 
60,000 Chemical National Bank 
200,000 Equitable Trust Co. 
200,000 Guaranty Trust Co. 
150,000 International Acceptance Bank 
200,000 National Bank of Commerce 
100,000 New York Trust Co. 
200,000 Royal Bank of Canada 
200,000 Seaboard National Bank 


200,000 First National Bank Boston 
250,000 First National Bank Chicago 
400,000 Merchants Loan & Trust Co. “h 
165,000 First National Bank Minneapolis 
150,000 Merchants National Bank St.Paul 
250,000 Anglo & London Paris Nat’| Bk. San Francisco 
150,000 First National Bank Chicago 


200,000 First Trust & Savings Bank : 


Days Rate 
to Run 

33/47 3 1/8% 
48 6c 
20/54 
85/88 3 1/8% 
pred tat 
75 
80 cc 
84 
61/69 . 
77 
61/78 er 
7OR7 Sh 


c¢ 


82 <4 
174 344% 
174 66 


The above bills are eligible for purchase by the Federal Reserve Banks. 
Please communicate promptly at our expense, either with us or with our 
correspondents listed below, in case you care to avail yourselves of the 


above offering. 
Telephone Rector 70 


Very truly yours, 


Ficure 27—List of offerings of bankers’ acceptances by discount house 


102 DOMESTIC AND FOREIGN EXCHANGE 


Some of these firms also carry on other financial transations of an 
international nature, such as the establishment of dollar acceptance 
credits in the United States, the opening of foreign credits on all parts 
of the world, the negotiating, collecting, and selling of all kinds of 
exchange, and, generally, the financing of foreign trade upon a 
reasonably short term basis. The acceptance companies are corpo- 
rations possessed of large amounts of capital. Some are owned jointly 
by a number of American banks, others are owned by American banks 
and foreign banks, while still others are owned solely by individuals. 
Some are incorporated under state laws; others under the federal 
laws.1 If we are to become an international financial power we must 
develop a system of discounting and accepting houses similar in 
character and importance to those of London. 

About a dozen or more foreign banking corporations have also been 
organized under the laws of the various states for the purpose of en- 
gaging primarily in banking, exchange, and other financial operations 
in foreign countries. Some of the more important of these are the 
American Foreign Banking Corporation, the Mercantile Bank of the 
Americas, the Asia Banking Corporation, the International Banking 
Corporation, the French American Banking Corporation, the First 
National Corporation, the Shawmut Corporation, and the Equitable 
Eastern Banking Corporation. 

The purchase and the sale of bank acceptances have become of such 
importance, especially in New York, that in 1920 a number of brokers 
began actively dealing in them. Every morning they make the rounds 
of the various banks with the list of the acceptances that they have 
for sale, inquiring at the same time as to what the banks themselves 
have for sale and at what prices. Certain investment houses in the 
more important cities have also started carrying an assortment of 
acceptances varying as to maturities and denominations, which they 
offer to their customers (banks and individuals) as excellent forms of 
short time investments. 

Behind the entire acceptance market, however, stand the twelve 

1 Typical examples of such firms are as follows: The Foreign Credit Corporation of New 
York City was incorporated under the laws of the State of New York in 1919 with a capital 
stock of $5,000,000. In 1921 it also had a surplus of $1,000,000. It is owned by two na- 
tional banks and four state banks. The International Acceptance Bank was also incor- 
porated under the laws of the State of New York. Its capital and surplus in 1921 were 
respectively $10,000,000 and $5,000,000. It is owned jointly by eleven national banks, 


seven state banks, trust companies, and investment firms, eleven foreign banks, and two 
foreign private banking companies. There are other acceptance houses of similar character. 


EXCHANGE DEALERS 103 


Federal Reserve banks, ever ready not only to rediscount acceptances 
for member banks, provided such acceptances fulfill the requirements 
laid down by the Federal Reserve Board, but also willing to go out 
into the market and buy for their member banks indorsed bills of all 
kinds and maturities which will be held for such banks, or sold for 
them as requested, or collected at maturity. This service has been 
rendered free of charge and has made it very easy for the member 
banks to keep their excess funds constantly and profitably employed 
through the continued or occasional investment in prime bills.1_ This 
service has been performed by the Federal Reserve banks solely for 
the purpose of acquainting the banks with the advantages of investing 
in acceptances, thus popularizing the practice and aiding greatly in 
the development of the discount market. The amount of acceptances 
bought in the open market by the Federal Reserve banks from 1915 to 
1920, inclusive, was as follows: 1915, $64,845,000; 1916, $386,095,000; 
1917, $909,301,000; 1918, $1,809,539,000; 1919, $2,825,177,000; 1920, 
$3,218,364,000. These data, although covering only the amount pur- 
chased in the open market by the Federal Reserve banks, clearly 
show the wonderful strides that have been made during the last few 
years in the growth of discounting and rediscounting domestic and 
foreign bills of exchange in the United States. 

The Federal Reserve banks do not provide their member banks 
with any of the ordinary exchange facilities in connection with foreign 
trade, i. e., they do not issue letters of credit, accept bills, sell drafts 
on foreign accounts, etc. A Federal Reserve bank, however, is au- 
thorized “with the consent of the Federal Reserve Board to open and 
maintain banking accounts in foreign countries, appoint correspond- 
ents, and establish agencies in such countries wheresoever it may deem 
best for any purpose of purchasing, selling and collecting bills of ex- 
change, and to buy and sell with or without its indorsement through 
such correspondents or agencies, bills of exchange arising out of actual 
commercial transactions.” ? It may also, “under rules and regulations 
prescribed by the Federal Reserve Board, purchase and sell in the 
open market, at home or abroad, either from or to domestic or foreign 
banks, firms, corporations, or individuals, cable transfers and bankers’ 
acceptances and bills of exchange of all kinds and maturities by this 
Act made eligible for rediscount, with or without the indorsement 


1 Annual Report of the Federal Reserve Board, 1920, p. 51. 
2 Section 14, Federal Reserve Law. 


104 DOMESTIC AND FOREIGN EXCHANGE 


of a member bank.’’! It is also authorized to deal in gold coin and 
bullion at home or abroad. On December 20, 1916, the Federal Re- 
serve Board approved the request of the Federal Reserve Bank of 
New York that it be allowed to appoint the Bank of England as its 
agent and correspondent, the relation to be reciprocal in character. 
The arrangement finally concluded on May 3, 1917, was of “a formal 
character, covered by written agreement . . . covering in detail 
the basis of the principal operations and making a close, effective and 
complete agency.” * During 1917 the Federal Reserve Bank of New 
York “acting for itself and other Federal Reserve banks, paid for 
account of certain English banks a loan of $52,500,000 with interest, 
maturing in New York, and accepted in return earmarked ® sovereigns 
of equivalent value in the Bank of England.” During 1918 all but a 
small amount of this gold was either shipped to New York or furnished 
to the Treasury Department for the use of the United States Govern- 
ment or its allies in Europe. During 1919 the Bank of England handled 
for the Federal Reserve banks the $173,000,000 of gold paid by Ger- 
many to the United States Grain Corporation for food supplies. The 
Bank of England transferred that sum to London from the Belgian 
and Dutch banks in which it has been deposited by the German gov- 
ernment, and held it subject to the orders of the Federal Reserve 
Bank of New York. A large proportion of this gold, although on 
deposit with the Bank of England, was later sold to American banks 
by the New York institution for export to the Far East. The remain- 
der was brought to the United States in 1920. Arrangements, al- 
though not the same in all cases as that described above, were also 
concluded with the Bank of France, the Bank of Japan, the Bank of 
Spain, De Javasche Bank (Java), De Nederlandsche Bank (Holland), 
the Bank of Italy, the Philippine National Bank, the Sveriges Riks- 
bank (Stockholm), the Norges Bank (Christiania), and with the 
governments of Argentina, Bolivia, Peru, and Great Britain. The 
greater part of these relations with the foreign central banks and 
governments are no longer in effect, owing to the passing of the 
critical conditions in the exchange market which had necessitated 
their establishment. Im all these agency relationships, the other 
eleven Federal Reserve banks participated with the Federal Reserve 


1 Section 14, Federal Reserve Law. 

2 Annual Report of the Federal Reserve Board, 1918, p. 330. 

? Earmarked”? means that the sovereigns were counted and actually set aside as being 
the property of the Federal Reserve Bank of New York. 


EXCHANGE DEALERS 105 


bank of New York upon the same terms and under the same con- 
ditions. 

As a result of the situation arising out of our entrance into the 
World War, the United States government placed all exchange matters 
under the complete control of the Federal Reserve Board. This was 
done by Executive Orders issued by the President at various times 
following September 7, 1917, which orders remained effective until 
in June, 1919, when practically all of the restrictions were removed. 
Such control was purely a war-time measure.'! In normal times it is 
not intended that the Federal Reserve Board shall function directly 
as a factor in the foreign exchange market. Its influence, however, 
can be, and possibly may be, made effective through the various 
Federal Reserve banks. 


B. ForEIGN EXCHANGE DEALERS IN ENGLAND 2 


In England the situation in some respects is different from that 
which exists in the United States; in others it is similar. The London 
market is centuries old, interwoven with long-standing customs and 
traditions, and characterized by practices that have developed as only 
they could in what has for centuries been the world’s center of finance 
and foreign trade. There the actual trading in bills of exchange, or 
at least a part of such trading, had, until December 30, 1920, a more 
formal character than in any other place in the world. Twice a week 
(Tuesdays and Thursdays) the bill-brokers who had business to trans- 
act in foreign bills gathered at the Royal Exchange, and for about an 
hour the buying and selling of bills took place. Clare in his “A B C 
of the Foreign Exchanges ”’* describes the Royal Exchange and its 
activities as follows: 


“There is perhaps no public edifice in the City [London], which is better 
known or less understood than the Royal Exchange. Familiar as its outlines 
are to the thousands of Londoners who daily pass by it, there is not one ina 
hundred that can tell why it was erected, or what purpose it serves. Nor, 


1 This will be more fully discussed in Chapter XIV, War and the Exchanges. 

2 The discussion which follows is concerned only with those phases of the London money 
market that affect the foreign exchange field, and touches only the part which they play 
in that connection. It is not designed to give the reader a complete survey of the English 
banking system. For such a survey consult the publications of the United States National 
Monetary Commission, F. A. Straker, ‘‘ The Money Market,” G. Clare, ‘A Money Market 
Primer,’’ A. Andreades, ‘“‘History of the Bank of England,” C. A. Conant, ‘‘ History of 
Modern Banks of Issue,” and similar volumes pertaining to that subject. 

3 Pp. 37-40. 


106 DOMESTIC AND FOREIGN EXCHANGE 


if they should enter it in quest of information would they be much the wiser, 
for at times they would find the interior either entirely deserted or only 
tenanted by a few loungers. It was not always so, however. The Royal 
Exchange was intended as a meeting place for merchants, and up to a quar- 
ter of a century or $o ago London merchants actually did meet there, each 
separate branch of trade collected in its own corner or round its own par- 
ticular pillar. But, as the various sections grew in numbers, it became more 
convenient to make homes for themselves in the localities that they specif- 
ically affect, and the coal, ‘wood, corn, produce, and other interests now 
possess their own separate Exchanges. 

‘“‘One important group still remains true to its allegiance. Twice a week, 
on Tuesdays and Thursdays,! the Royal Exchange wakes up for a brief 
space. Immediately after luncheon-time, those who have business to 
transact in foreign bills begin to gather at the eastern end of the courtyard 
and for about an hour ’ Change is held. The assemblage which is not a very 
large one—not more than perhaps five or six score at the outside—consists 
of a small number of brokers and of the chiefs of all the great foreign banking 
houses. Of bankers, in the ordinary acceptation of the term, scarcely one is 
to be seen, except on rare occasions; London being perhaps the only great 
capital in the world of which the home-banking interest is not regularly 
represented on the "Change. There is an entire absence of noise or excite- 
ment. So quietly is the business transacted that it is difficult for the on- 
looker to believe that anything is going on. Now and again one observes 
a broker draw a likely buyer aside, covertly exhibit a contract-note and 
suggest a price in a whisper. A simple nod of the head, almost imper- 
ceptible to a bystander, signifies acceptance; the broker scribbles down 
the rate, passes over the contract, which the banker thrusts unconcernedly 
into his pocket, and the bargain is complete. In an hour or so all is over, 
and the broker hurries back to his office to write out his course of exchange, 
or list of current prices.”’ 2 | 


The London papers the next morning contained the list of prices 
or the rates of exchange which had prevailed on the Exchange. This 


1 Note by Clare: ‘‘ Formerly Tuesdays and Fridays were the only days on which foreign 
mails were dispatched from London, and on those days alone were foreign bills negotiable 
on ’Change. It had always been the custom that bills bought on one ‘post day’ should 
be paid for on the next; but a notorious case (and not the first) having occurred of a house, 
that had bought cheques to a large amount, stopping payment before the following post 
day, thereby involving the sellers in heavy loss, it was arranged in 1879 that, for the future 
all bargains should be settled the next morning, in order that, if a similar case happened 
again, the cheques might be stopped by telegraph. At the same time the second day was 
altered to Thursday, as it was not to the convenience of the great Jewish houses to pay on 
Saturday.” 

2 Cf. Ernest Seyd, “Bullion and Foreign Exchanges,” London, 1868, pp. 434-436; Straker, 
op. cit., pp. 133-135. 


EXCHANGE DEALERS 107 


list was much less important, and was scanned much less carefully, 
than the daily table of rates cabled from abroad, because most of the 
business in which the foreign exchange dealers are interested concerns 
not the bills drawn im London on foreign centers but those drawn in 
foreign centers on London. Nevertheless, the list was of importance 
as showing the trend of the exchanges. 

These semi-weekly meetings of the Royal Exchange were the only 
instances of the formal marketing of bills of exchange in London. 
Otherwise the market has always been as open and as informal as it 
is in the United States. 

The reason for the abandonment of the Exchange meetings is nicely 
summarized in the London Times under date of December 24, 1920: 


“An institution which has existed in the City for generations is about 
to come to an end, owing to the altered conditions existing at the present 
day... . Originally these dealings were chiefly in the form of bills; now- 
adays, with the telephones and telegraphs in operation, dealings in foreign 
exchange take place at a furious pace all day long. ... The necessity 
for the old post-day meetings has therefore largely disappeared; hence it 
has been decided for the present to discontinue these bi-weekly meetings 
after Thursday next.” ‘ 


The agencies that are active in the English exchange market are: 
(a) the bill-brokers; (b) the discount houses; (c) the merchant 
bankers and accepting houses; (d) the branches of London offices 
of foreign and colonial banks and financial houses; (e) the English 
private and joint stock banks; and (f) the Bank of England. Each 
plays its part in the daily transactions that arise in connection with 
the accepting, negotiating, discounting, and collecting of claims for 
untold millions of pounds sterling arising out of both domestic and 
foreign trade. 

The bill-brokers and discount houses are peculiarly English in- 
stitutions, only in exceptional cases are they found on the Continent, 
and, as we have noted earlier, it is only during the last few years that 
they have appeared in the New York market to perform the same 
function that they do in London. There are only a few of the “run- 
ning ”’ bill brokers, 1. e., those who do not themselves make a practice 
of actually purchasing the bills, but who go from bank to bank or from 
firm to firm, selling and buying for others on a commission and always 
using funds supplied by their clients. There are about twenty dis- 


108 DOMESTIC AND FOREIGN EXCHANGE 


count houses that are actual dealers in exchange, buying and selling, 
and having offices and funds of their own. Three of these discount 
houses, viz., The Union Discount Company, Ltd., The National Dis- 
count Company, Ltd., and Alexanders Discount Company, Ltd., are 
incorporated;' the others are private partnerships. Both groups work 
with their own capital and also with funds which they attract in the 
shape of deposits from customers (just as in the case of a banking con- 
cern). Interest is paid on these deposits, the rate being based on that 
prevailing in the market, usually at the bankers’ seven day rate for or- 
dinary commercial checking deposits or accounts (in England known as 
“call deposits’) and one-quarter per cent additional for time or sav- 
ings deposits (known in England as “short notice” deposits). It is also 
the custom of the discount houses to borrow large sums from the 
private and joint stock banks, and, in times of need, when all other 
sources fail, to have recourse to the Bank of England where they 
either borrow for a few days (usually from three to ten days) the sum 
which they need to care for their business, or else discount (sell) some 
of their bills and thus put themselves in funds. They also make loans 
on negotiable securities, buy and sell stocks and bonds, and at times 
underwrite new issues of corporation securities, but they do not issue 
letters of credit, drafts, or other forms of exchange instruments. 

The principal function of the brokers and the discount houses, both 
of which are frequently known only as “brokers,” is to provide a 
market for bills of exchange. The running brokers intervene between 
buyers and sellers and charge a commission for their services, but 
the discount houses actually buy the bills that are offered for sale. 
The discount houses keep a considerable portion of these bills until 
maturity, thus earning the discount thereon. Other bills they sell 
to banks and investors at a slightly different rate of discount than 
that at which purchased, and make their profit on the difference be- 
tween their buying and their selling rates. English and continental 


1 The National Discount Company, Ltd., was established in 1856. It has a subscribed 
capital of £4,233,325, of which £846,665 is paid up. Its reserve fund is £500,000. In its 
balance sheet for December 31, 1920, it showed a total of £32,406,636 worth of bills dis- 
counted, £12,114,742 of which it had sold to others. 

The Union Discount Company, Ltd., was established in 1885. Its balance sheet of 
December 31, 1920, showed a capital stock of £2,000,000, of which £1,000,000 was paid 
up. Its reserve fund was £1,000,000. Bills discounted stood at £41,079,452. 

Alexanders Discount Company, Ltd., was established in 1810 and incorporated in 1891. 
Its balance sheet for December 31, 1920, showed a capital stock of £1,000,000, of which 
£550,000 was paid up; a reserve fund of £270,000, and bills discounted at £18,063,470. 


EXCHANGE DEALERS 10g 


bankers know the advantages of the acceptance as a form of short 
time investment. They prefer, however, to purchase them from the 
discount houses rather than to deal directly with the acceptors be- 
cause the discount houses specialize in that particular class of paper, 
and know the exact credit status of each acceptor in the London 
market, the genuineness of the signatures, the amount of the paper 
which each acceptor is likely to have outstanding, and all other re- 
lated facts. Discount houses have many sources of information on 
these matters and keep their data up to date. In the field of foreign 
trade and finance the standing of a firm may change almost over- 
night, so that there is constant need of investors being closely in touch 
with the latest developments. Thus far the banks have seen fit to rely 
solely upon the discount houses in such matters. Discount houses can 
provide the banker with just the kinds of bills that he desires, the 
proper amounts and maturities, so that he can keep his portfolio filled 
with the right kinds of paper. Many of the banks on the Continent, 
including the central banks of Germany, France, Italy, Belgium, and 
Holland, invest heavily in sterling acceptances. They, too, make 
their purchases primarily through the discount houses. Also, the 
small English banks outside of London, find that it is not possible to 
obtain enough, or at times the right kinds, of acceptances from their 
customers in which to invest surplus funds, so that they, too, have 
need of recourse to the discount houses to fill their portfolios. These 
acceptances are looked upon as being the very best kinds of bills for 
short time investment. If an English bank does not wish to hold the 
bills until maturity, it may easily sell them again to a discount house, 
to one of the private or joint stock banks in London, or to the Bank 
of England itself. In actual practice, however, it is not customary 
for English banks to rediscount the acceptances which they have 
purchased for their own needs. 

“The function of the discount house is thus of considerable impor- 
tance in the London money market, because the terms on which they 
do business may have a considerable effect upon the foreign exchanges 
and so upon the inward and outward movement of gold. Ultimately 
and in the long run it is probable that the discount rates current in 
the London money market are decided by the banks themselves since 
if the bankers decide that they will not buy below a certain rate that 
rate is almost certain to become speedily effective. Nevertheless the 
discount houses may have a considerable effect on the rates current, 


110 DOMESTIC AND FOREIGN EXCHANGE 


since if they take a strong view concerning monetary probabilities 
in London their sentiment is almost certain to express itself on the 
rates current for the moment.” ! 

It is not usual for the discount houses to indorse the acceptances 
which they sell to others. It is customary, however, for them to have 
a standing “guaranty” with the banks to which they sell large 
amounts, which guaranty is, practically, the equivalent of an indorse- 
ment. ‘In consideration of the bill-broker’s guarantee and of having 
the advantages of his knowledge in selecting and collecting bills, a 
banker is content to buy bills from a broker at a slightly lower rate 
than the ruling market rate, usually 1/8th or 1/16th per cent per 
annum lower. For instance, if bank or first-class paper is quoted 
in the market at 2 3/8ths per cent per annum for bills due in three 
months’ time, bankers would buy such bills from the broker at 2 %4 
percent. The broker thus makes a turn of about 1/32nd per cent on 
the deal, but in active times this ‘turn’ is often divided with the mer- 
chant from whom he buys. This profit may seem small, but when the 
enormous turnover of a bill-broker is taken into consideration, it is 
apparent that the total profits derivable from this business are 
very considerable. This is confirmed by the satisfactory dividends 
paid by two or three public companies conducting discount busi- 
ness.”’* 

The brokers and discount houses are very heavy borrowers from 
the banks, either at call or at short notice rates. The security for 
such loans is either “first-class bills or what are known as ‘floaters.’ 
‘Floaters’ are bearer securities of the highest class, such as Consol 
certificates, the debentures of certain Indian railways, the bonds 
of the Corporation of London, and the London City Council. They 
obtain the name of ‘floaters’ from the fact that they float from bank 
to bank, as one bank calls and another lends.’?? When the money 
market gets tight and the brokers and discount houses have to borrow 
from the Bank of England (they are then said to be “in the Bank”), 
the latter charges them a slightly higher rate, ranging from one-half 


1 Withers, Hartley, ‘‘The English Banking System,” United States National Monetary 
Commission Reports, 61st Congress, 2d Session, Senate Document No. 492, pp. 62-63. 

2Straker, op. cit., pp. 108-109. The following dividends were paid for 1920: Union 
Discount Company, Ltd., 28 per cent; National Discount Company, Ltd., 24 per cent; 
Alexanders Discount Company, Ltd., 28 per cent on common shares and 12 per cent on 
preferred shares. 

3 Straker, op. cit., pp. I1I-I12. 


EXCHANGE DEALERS IIt 


to one per cent higher, than the official Bank rate. Such loans usually 
run from three to ten days. 

From the above discussion it can be readily appreciated that the 
brokers and the discount houses are a very important and influential 
factor in the London money market. 

The merchant bankers and accepting houses were among the first 
to specialize in accepting bills for customers. “The importance of 
the acceptor’s name on a bill . . . led merchants of first rate standing 
to specialize in this form of business. They gradually let off or reduced 
the amount of their actual mercantile business and confined them- 
selves to accepting bills, for a commission, for others whose credit 
was less well established. . . . The business of acceptance has thus 
grown up an important and separate function which is largely in 
the hands of the leaders among the old merchant firms, whose accept- 
ance of a bill stamps it at once as a readily negotiable instrument. . . . 
Other functions of the merchant firms and accepting houses are their 
activity in general finance and in exchange business. Both of these 
functions arise out of their old business as merchants, which gave 
them close connection with the governments and the business com- 
munities of foreign countries. ‘Their connection with the govern- 
ments naturally led to their providing credit facilities for them, and 
to their handling loans and other operations which these governments 
might have to conduct in the London market. Many of them act as 
regular agents of foreign governments, making issues of bonds on their 
behalf, paying their coupons, and conducting amortization and other 
business in connection with their loans; and their connections with the 
general business community led inevitably to their doing a consider- 
able exchange business with foreign countries, financing drafts on 
them for purposes of travel and the innumerable other arrangements 
which necessitate the transfer of credit from one country to another.” } 
It is interesting to note that the board of directors of the Bank of Eng- 
land is chosen mainly from the ranks of the merchant bankers and 
accepting firms. 

There are in London (1921) sixty-eight offices or branches of foreign 
banks, representing practically every country of the world, many of 
which act as correspondents for other banks located not only in the 
home country of the branch or office itself but in other countries as 


1 Withers, H., “The English Banking System,” pp. 54-57. 


II2 DOMESTIC AND FOREIGN EXCHANGE 


well.! These foreign and colonial banks, as can be surmised, are most 
actively engaged in and concerned with practically all phases of 
foreign exchange. They issue letters of credit, act as accepting houses, 
discount bills, and provide exchange facilities for many banks located 
in their own and in other countries. It was the fact that they were 
so successful in the foreign exchange field and were, as a result, able 
to compete with London banks in other lines of banking activities, 
that finally compelled the private and joint stock banks of England 
to engage in the foreign exchange business. It was as late as 1905 
that the first foreign exchange department was organized by an Eng- 
lish joint stock bank, which is now the London Joint City and Mid- 
land Bank.” At the time this unprecedented action aroused the 
hostility of English joint stock and private banks, but it has since been 
widely copied by them. Having once entered the field, it was easy 
to take the next step, and the private and joint stock banks then 
undertook to act as accepting firms. In so doing, however, they 
aroused the opposition of the older merchant accepting houses. The 
latter claimed that the banks did not have the special training needed 
to become acceptors, and also that there was an anomaly in their 
being acceptors of bills of exchange and at the same time guardians, as 
they necessarily have to be, of the volume of acceptances created by 
other accepting firms. It was felt that if they became acceptors they 
would tend to discriminate against the acceptances created by the 
merchant bankers and the accepting houses. The banks, however, 


1The Economist of London, in its issue of Oct. 22, 1921, gives the following data con- 
cerning colonial and foreign banks with branches or offices in London: 
Colonial Joint Stock Banks with London Office: 
6 African banks with 979 branches elsewhere. 
15 Australian banks with 2,364 branches elsewhere. 
8 Canadian and West Indian banks with 2,784 branches elsewhere. 
4 Indian banks with 94 branches elsewhere. 


Total, 33 Colonial joint stock banks with 6,221 branches. 
Foreign Banks with London Offices: 
17 Continental banks. 
5 Asiatic banks. 
6 South American banks. 
5 United States banks. 
Total, 33. 
2In October, 1907, the Journal of the Institute of Bankers (English) stated, “‘For some 
time past there have been signs that some of the English joint stock banks favored the 
idea of getting into their own hands some of the foreign exchange business which has been 
so largely under the control of foreign banks and firms. An important step in this direction 
has been taken by the London and County Bank, who announce that they have purchased 
the business of Messrs. Fredk. Burt & Co., of 80 Cornhill, and that they will from October rst 
carry on at that address a Foreign Exchange Branch of the Bank. It will be interesting to 
see if this example is followed by other banks.” 


EXCHANGE DEALERS 113 


have not allowed these objections to interfere with the development 
of the acceptance phase of their business. 

The joint stock banks are undoubtedly the most important factors 
in the London money market outside of the Bank of England. Until 
lately there have also been a number of private banks in England, but 
since 1896, and especially during and since the Great War, they have 
been rapidly absorbed by a few of the more important joint stock 
banks until today (1922) private banks are almost non-existent. 
Banking in England is now dominated by a few of the joint stock 
banks (known as “The Big Five”: the London Joint City and Mid- 
land; Lloyds; London County, Westminster and Parr’s; Barclays; and 
the National Provincial and Union!) either through their having 
combined with or purchased outright a number of other banking in- 
stitutions, or through control exercised by their owning a large por- 
tion of the stock of these latter banks. 

The English banks have been very slow to establish branches in 
foreign countries ? although in the British Isles themselves branch 
banking has long been an accepted practice.* It has been the foreign 
banks, colonial and others, controlled by English capital and with 
their main offices sometimes in London, sometimes not, that have been 
so active in spreading a network of branches over the face of the earth.‘ 


1The progress made in the absorption of the private banks and the tendency toward 
combination of banking resources are shown by the following data: 


Private Banks Joint Stock Banks 
Year No. of Banks Year No. of Banks 
1895 38 18990 123 
1900 19 1895 118 
1905 12 1900 96 
IgIo 9 1995 79 
IQIS 7 1910 63 
1920 5 I9I5 55 


1920 37 

The control exercised by the Big Five through stock ownership is not disclosed in the 
above table. 

2 The situation as it applies to the English joint stock banks is aptly characterized by 
an article which appeared in the New York Annalist on March 5, 1917, written by that 
journal’s London correspondent. In part it stated that: 

“The number of British banks with direct connections abroad are few. Lloyds Bank 
has a subsidiary enterprise in France known as Lloyds Bank (France) and the London 
County and Westminster Bank has a branch in Paris . . . but even bolder is a step just 
taken by the London County and Westminster Bank. This concern has decided to open a 
eee Spain. ... No other purely British bank is represented in Spain by branch 
offices.’ 

3In 1890, 123 English banks had a total of 3,634 branches. In 1920, 37 banks had a 
total of 9,452 branches. 

4 As noted above, 33 colonial joint stock banks with London offices controlled a total 
of 6,221 branches. 


II4 DOMESTIC AND FOREIGN EXCHANGE 


The private and joint stock banks do a general banking business, re- 
ceiving deposits and paying interest thereon, holding the accounts 
of domestic and foreign correspondents, selling and buying foreign 
exchange, accepting and discounting bills, etc. They also loan large 
amounts of money to bill-brokers and discount houses. When they 
become hard pressed for funds they rediscount some of their bills 
with the Bank of England, although it is not the practice of the joint 
stock banks to discount freely with the Bank of England. While the 
Bank is willing to act as a rediscounting agency, nevertheless, as noted 
above, it is the custom of the joint stock banks to hold until maturity 
the bills which they purchase. The banks of France and Germany 
have much less hesitancy about discounting with the central bank of 
their respective countries. In fact, with them it is the customary 
thing, as a consequence of which the “intercourse between customer 
and bank on the one hand, and the bank and the central bank on the 
other, is a pretty direct one. While a large business is still done by 
brokers and consequently in the open market, the majority of the 
transactions is carried on directly between customer and bank and 
bank and central bank.” ! 

“In England, banks and bankers generally avoid accepting long 
bills for home customers, whom they prefer to accommodate by cash 
advances, but they accept very largely for out-of-town customers. 
The joint stock banks in England make it a rule to accept only against 
collateral, while important banking firms and banks, which often 
make accepting their exclusive business, grant uncovered credits to a 
very large extent. In France and Germany no line of demarcation 
of this kind exists; banks, large and small, private bankers as well, 
accept with or without collateral, according to their own best judg- 
ment. The aggregate amount that a firm in any of these countries 
will accept, must, of course, bear a certain relation to its own re- 
sources. But this proportion differs according to the character of 
the general business done by such firm. A bank doing an extensive 
general banking business will accept to the extent of its capital only, 
while banks or bankers devoting themselves exclusively to the busi- 
ness of accepting will accept an aggregate amount representing many 
times their own capital.” ? 


1 Warburg, Paul M., ‘‘The Discount Market in Europe.”’ Publications of the United 
States National Monetary Commission, 61st Congress, 2d session, Senate Document No. 


4o2, p. 18. 
2 Ibid, p. 11. 


EXCHANGE DEALERS II5 


Back of the entire banking and credit structure of the country 
stands the Bank of England, known familiarly as “The Old Lady of 
Threadneedle Street.”’ It is a mountain of strength to the banking 
interests of the British Isles, and while not the largest bank in the world 
so far as capitalization, assets, etc., are concerned, it is nevertheless 
the most important financial institution because of its dominating 
influence in the world’s money market. It deals directly with banks, 
firms, and individuals, holding their deposits, loaning funds, discount- 
ing bills, etc. It is not a bankers’ bank as are the Federal Reserve 
banks. English banks may, but are not required to, keep their re- 
serves with the Bank of England. When these reserves fall low, they 
are readily replenished by the individual bank rediscounting some of 
its bills with the Bank of England. Such bills, to be eligible for 
rediscounting, must be presented by a party having a deposit account 
with the Bank, must not be payable in other countries, and must bear 
two British names, one of which must be that of a British acceptor. 

The Bank of England does not act as the acceptor of bills of ex- 
change, nor does it provide its customers with any of the ordinary 
exchange facilities. It has no list of correspondents scattered over 
the world through which to conduct exchange transactions. In con- 
nection with the field of foreign exchange it performs three functions. 
First, it rediscounts bills for its depositors. We have already discussed 
its activities in that regard. Second, it is an active participant in the 
gold market, buying and selling that precious metal in large amounts, 
and regulating, when necessary, its flow into or out of the country, 
primarily by raising or lowering its rate of discount, known popularly 
as the “Bank rate.” Third, it practically determines the money 
rates in the London market, and thus incidentally influences the money 
rates throughout the world, by manipulating its Bank rate. This 
rate, published in normal times every Thursday morning by the 
directors of the Bank, and immediately cabled to all financial centers, 
is the rate at which the Bank will discount prime three months’ bills 
which are presented to it or advance money against the deposit of ap- 
proved securities. Interest and discount rates in the English market 
go up and down with the fluctuations in the Bank rate, as will be more 
fully brought out later. The details of the functioning of the Bank 
in the gold market and the influence that it wields through its official 
Bank rate will be dealt with at length in Chapters X and XI. 


CHAPTER VI 
PRINCIPLES OF FOREIGN EXCHANGE 


The origin of foreign bills of exchange is lost in antiquity and will 
doubtless so remain. We know, however, that they were used during 
the heyday of the Roman Empire. Cicero, for example, mentions 
bills of exchange as being in common use in his time and the inference 
is that they had been in use for many years prior to that date. It is 
thought by some writers that they were introduced into the northern 
provinces of Europe by the Jews, as a means of transferring their 
belongings to foreign countries in a way that would be safe from the 
demands of the “robber barons ” through whose countries they were 
compelled to travel. We know that bills of exchange began to be 
rather widely used in France and England during the early part of 
the twelfth century. Charters given to various cities during the 
twelfth and thirteenth centuries authorized the cities themselves to 
deal in such bills. Macleod tells us that the growing power and arro- 
gance of the popes had a great deal to do with the extension of their 
use. At the “time of the Crusades they [the popes] claimed the right 
to tax all Christendom for their support. They had their own money 
dealers, termed Camdzatores, who kept tables in the capital cathedrals 
to exchange the money of foreigners who came to worship. These 
persons sent their own agents into different countries to collect the 
Papal tribute. As soon as they had collected a sufficient amount, they 
sent the Pope bills upon their principals and correspondents for the 
amount..... These bills were’naturally in the form of an order 
upon their principals to pay a certain amount of the money of the 
country they were in at a certain rate of exchange in Italian money. 
In the r2th century Florence became especially famous for this ‘ bank- 
ing business,’ as it was called. Lucca, Siena, Milan, Placentia, and 
others were also famous.” 1 From that time, primarily as a result 
of expanding commerce and the developing need for a satisfactory 

1Macleod, H. D., ‘‘Theory and Practice of Banking,” 3d ed., London, 1875, Vol. I, 
}.. 196. An excellent summary of the early history of bills of exchange, together with ex- 


amples of such bills, is given on pp. 195-203 of that volume. 
116 


PRINCIPLES OF FOREIGN EXCHANGE 117 


method of handling financial transactions between traders living in 
different countries, bills of exchange became increasingly prevalent. 

The principles underlying foreign exchanges are practically the | 
same as those underlying domestic exchange, the most important 
of which is the settlement of debts without the shipment of gold or 
silver. Credit instruments are used to an even greater extent than 
in domestic transactions, although, strangely enough, it more fre- 
quently becomes necessary or profitable to engage in the shipment 
_ of the precious metals. Because very few business firms or individuals 
have checking or commercial accounts with foreign banks, the bank 
check, as we know it in our ordinary domestic business relations, is 
seldom employed.! There is no international clearing house for 
foreign bills of exchange. Bills provided or created either by a third 
party or by the creditor play a much more important part in inter- 
national transactions than do bills created by the debtor. At times 
the exigencies of the situation necessitate the use of certain kinds of 
credit instruments totally unlike those found in domestic affairs. 

A matter which causes the greatest amount of confusion, especially 
for the beginner, is the fact that documents and bills of exchange are 
drawn usually in terms of the money of a foreign country. At home 
when we ship goods to a fellow-countryman, we charge him dollars 
and we receive dollars, either in cash or in the form of credit. Our 
domestic transactions are carried on in terms of our own unit of value, 
the dollar. When we sell goods to an Englishman, however, we ordi- 
narily charge him so many pounds sterling, although lately the practice 
has been growing of charging him so many dollars, just as we do with 
our domestic customers. In the past our foreign bills have almost 
always been drawn in terms of foreign moneys ? because “in former 
years the American Dollar was a pariah among the foreign moneys. 
There was no market in American exchange other than an arbitrary 
one and the price was dictated absolutely according to the whims and 
fancies of the foreign banker. In the event of a merchant desiring 
to sell an American draft, he was obliged to suffer a discount of from 
one, two and three per cent and if he wanted to buy a draft, the re- 
verse operation would be put into effect and he had to pay an exceed- 
ingly high premium.” ® 

1Cf. p. 38. 

2 Not always, however, in terms of the money of the customer’s country. 


3 Gardin, J. E., Vice-President, National City Bank of New York, in Number Eight, 
August, 1916, p. 3. 


118 DOMESTIC AND FOREIGN EXCHANGE 


Exchange rates on foreign countries were fairly stable, and we 
knew just about what our bills drawn in foreign money would be 
worth in the exchange market. Those conditions, however, no longer 
exist. With the unsettled conditions caused by the World War it was 
and has been impossible for us to know from day to day the value 
of any foreign money in terms of the dollar, but we have known that 
if we drew our bills in dollars, and compelled the foreign customers 
to pay us enough of their money at the prevailing exchange rates to 
equal those dollars, we would be fairly certain not to lose on the trans- 
action. At times we have even compelled the foreign buyer to pur- 
chase with his own money a draft drawn in terms of dollars and to 
remit it to us so that we might have the dollars in hand rather than 
to have the dollars’ worth of foreign money added to our accounts in 
foreign banks. By so doing the American exporter has been able to 
shift the risks of exchange to the shoulders of the foreign customer. 
Whether or not, after international relations return to normal, we 
shall resume our former practice of drawing foreign bills almost solely 
in terms of foreign currencies is a matter concerning which definite 
prophecy is impossible, although at the present time (April, 1922) it 
seems that the pound sterling will, to a considerable extent, regain 
its dominancy among the exchanges, with the dollar retaining at | 
least some of the importance gained during the last few years, es- 
pecially in the financing of South American trade. 

The elements that constitute the content of foreign trade neces- 
sitating the use of exchange instruments are of the same character as 
those that constitute the content of domestic trade. We have those 
“visible”? items, such as the exports and imports of raw materials 
and manufactured goods. We also have those “invisible” items, 
such as the sums remitted or received for the payment of dividends 
and interest, insurance premiums, ocean freight charges; funds for 
clients, financial correspondents, friends, and relatives; expenditures 
of travelers, etc.1 

Until within the last few years the United States has been classed as 
a debtor nation, its citizens and firms owing abroad more than was 


’ The case of Greece presents an interesting instance of the really important part played 
by the invisible items in the foreign trade of some countries. A recent report of the Amer- 
ican Consul General at Athens states that remittances (funds sent to Greece) increased 
from thirty-three million drachmas in 1914 (a drachma is quoted roughly as having a par 
of $.193) to three hundred and fifty million drachmas in 19109, in the latter year amounting 
to seven-ninths of the total trade balance against that country. 


PRINCIPLES OF FOREIGN EXCHANGE 119 


owing to them.' The most customary method of paying such an in- 
debtedness is, of course, by the shipment of goods. Before the World 
War leading authorities agreed that we were compelled to have an 
excess of exports over imports varying from $400,000,000 to $600,000,- 
ooo annually in order to settle our annual foreign indebtedness without 
being forced to export gold. This excess of exports was required to 
pay interest and dividends of from $200,000,000 to $300,000,000 on 
American securities of various kinds held abroad, the expenditures 
of tourists varying from $150,000,000 to $200,000,000, remittances 
by Americans to friends and relatives estimated at from $100,000,000 
to $150,000,000, and payments to foreign shipowners for ocean freight 
charges ranging between $20,000,000 and $40,000,000.” As a result 

1In an address delivered before the California Bankers Association in San Francisco, 
Cal., May 27, 1915, Dr. Ewing Pratt, formerly Chief of the U. S. Bureau of Foreign and 
Domestic Commerce, stated that at the outbreak of the European War the United States 


owed no less than £1,500,000,000 (about $6,000,000,000) to Europe, the largest portion 
of which was distributed as follows: 


PUNGIANG. ioc) oe ais.ae as x ae VAs O00/000;Q00 
CEATICE so here cc aie eae aie aes I,000,000,000 
Germany: ine Sto cl eer I,250,000,000 
Hollsnd os sete wae ae ae « 650,000,000 


Part of this indebtedness was offset by loans which we had made to European countries, 
and by our holdings of certain European securities, so that it would seem that at the open- 
ing of the World War we owed Europe approximately $6,000,000,000. (Proceedings, 
California Bankers Association, 1915, p. 66.) 

2Dr. Ewing Pratt, in the address cited above, also discussed our balance of trade and 
how we met our obligations therefor during what may be called a normal year, the fiscal 
year ending July 1, 1914. He said: “In order to show this balance clearly it might be 
worth while to strike a very brief balance-sheet, and to find out exactly where we stood at 
the beginning of the European War. Our balance of trade, both visible and invisible, 
during the last fiscal year [1914] would, therefore, be something as follows: 


FOREIGN TRADE OF THE UNITED STATES DURING THE FISCAL YEAR 1914 











Merchandise Remittances 
ERTOGELSatewese cists ena $2,365 ,000,000 Interest (net)....... $250,000,000 
TM pOris.. se. Loe u: 1,894,000,000 Tourist expenditure 
= (net) Ra cesint ten sre 170,000,000 

Excess of exports over imports.....$471,000,000 Remittances to friends 

Gold (TICE eee ae terste 150,000,000 
HGSPOLUS Creare “ass a ec0 112,000,000 Beis itovts @ «c/s 0 vera 25,000,000 
IPIGOLES vests, she's 9) Seka 67,000,000 
Excess of gold exports over imports.. 45,000,000 

Silver 
BS pOrts.- i eo oe cs 55,000,000 
MM GOLES Acie es ete so « 30,000,000 





HSS ——————_ $505,000,0co 
Excess of silver exports over imports 25,000,000 : ——————— 
— Excess of sum remitted over trade 

SVGEAMCRCOSS a eer ah hn, oie se soos oily eis $541 ,000,000 balancestis.: ss nea. olohintee Acme $ 54,000,000 


— 





“This balance sheet shows that we had payments to make in Europe over and above 
the total amount of merchandise exported, and this fact means that we were still con- 
tracting debts in Europe at the outbreak of this war. But the situation has changed since 
the rst of August, 1914.” 


I20 DOMESTIC AND FOREIGN EXCHANGE 


of the World War, however, the situation has been reversed, and we 
now find ourselves a creditor nation of surprising proportions. The 
Federal Reserve Board has estimated that our total unfunded inter- 
national balance accrued since the Armistice, excluding the war-time 
debts of foreign countries to the United States (approximately $10,000- 
000,000) amounted to some $3,000,000,000 in August, 1920,' to $3 ,408,- 
000,000 on October 1, 1921,” and to $3,400,000,0000n January 1, 1922.° 
The volume and value of our foreign trade have increased at a rapid 
rate since 1914. The maximum expansion in volume was attained 
in 1917 although the maximum value was reached during 1920.* 
Our excess of exports over imports during the period of the war and 
to the end of 1921 approximated $20,000,000,000.° The task of paying 
for such large amounts of goods has taxed the minds of the world’s 
financiers and has placed an enormous burden upon the purchasing 
nations. It has naturally involved foreign exchange problems of the 
most interesting, complex, and varied sort. But as a prominent 
banker has well said: 


“Every exchange transaction is reciprocal: you give something and you 
get something. You transfer goods or render services to others in return 
for goods they transfer or services they render to you. And exchanges 
go on so long as they are mutually profitable. It is ‘fair exchange’ that 


‘ Federal Reserve Bulletin, September, 1920, p. 1262. 

2Ibid, November, 1921, pp. 1262-1266. 

3 Ibid, February, 1922, pp. 128-120. 

4 The great increase in prices explains the seeming contradiction contained in the above 
statement. 


5 MERCHANDISE IMPORTS AND EXPorTS OF THE UNITED STATES 
IQII-IQ21 


(o00 omitted) 


Exports Imports Excess Exports 
TO2T os ek: Ue ee $4,485,000 $2,509,000 $1,976,000 
TH20:. 555) nee 8,288,016 5,278,481 2,040,535 
TOTO Meda bane 7,920,425 3,904,364 4,016,061 
TOT hae es alae Toe 6,149,087 3,031,212 3,117,875 
EOLA eee eee ee 6,233,512 2,052,467 3,281,045 
TOTO tN ahaa Wr 5,482,641 2,391,635 3,091,006 
TOUS cians Gee ieee 3,550,015 1,778,605 1,772,309 
TOL foe aoe poke 2,104,257 1,789,022 325,235 
LOUD ar ee ha, erated os, ca 2,484,018 1,792,596 691,421 
LOL36 7s 2 ean ahem 2,390,217 1,818,073 581,144 


TOL Dacian een ak 2,002,526 1,582,359 560,167 


PRINCIPLES OF FOREIGN EXCHANGE I2I 


‘is no robbery.’ This means that the goods and services that this country 
furnishes to other countries will represent goods and services of equal value 
furnished to this country by other countries. Our exports of merchandise 
will never exactly balance our imports of merchandise, but our exports of 
merchandise plus the services that we render other countries will equal in 
value the imports of merchandise plus the services that other countries 
render to us. There is no escape from such a conclusion unless men are 
to quit exchanging things of equal value and begin giving things away. 
We hear a lot about our export trade, but our export trade involves an 
import trade. The nation that will not buy, neither shall it sell.’’ 1 


Our stupendous favorable balance of trade has been paid for in the 
first place by huge importations of gold. From August 1, 1914, to 
December 31, 1921, our excess gold imports totaled $1,542,119,000. 
We have also loaned huge sums to private parties and to foreign 
governments. Private loans made by individual citizens through 
banking and investment houses to foreign political units have 
amounted roughly to $2,000,000,000. Our government has loaned to 
foreign nations, both during and after the war, approximately $9,500,- 
000,000. To enable the United States to purchase the needed supplies 
for our army in Europe, England, France and Italy advanced a sum 
of their currencies equal to $1,490,557,111. We have repurchased 
from European holders close to $3,000,000,000 of American securities. — 
We have also invested heavily in ventures of all sorts in various parts 
of the world, the extent of which it is not possible to estimate with any 
degree of accuracy.” We have sent money abroad to friends and 
relatives, insurance companies, freight carriers, and to the needy of 
Europe. The export of American funds in such large amounts and 
their use in various ways have aided greatly in the temporary settle- 
ment of Europe’s indebtedness to us arising out of its huge adverse 
balance of trade. Because it is through foreign exchange transactions 
that such indebtedness between different countries and the peoples 
of those countries is cared for, it is not strange that the subject of the 
exchanges has loomed large in all discussions in financial circles since 


1914.° 


1 Dwight L. Morrow, Commercial and Financial Chronicle, Nov. 6, 1920, p. 1801. 

2 Cf. pp. 332-336. 

2 The following most excellent survey of this unique situation appears in a pamphlet 
issued by the Guaranty Trust Company of New York City (1921) entitled ‘Our New 
Place in World Trade”’: 

‘‘For convenience, we may now sum up the known items, both visible and invisible, of 


122 DOMESTIC AND FOREIGN EXCHANGE 


In normal times and even in abnormal times efforts are made by 
those dealing in the exchanges to obviate the shipment of precious 
metals. Claims of the citizens of one country on those of another 
must be paid, if not by the shipment of goods, the rendering of ser- 
vices, etc., then by the shipment of either gold or silver. While gold 
cannot correctly be called the “international money,” it is neverthe- 
less the most important metallic medium or basis of exchange in all 
foreign relations. In normal times practically all of the countries of 
the world are on a gold standard basis, the unit of their monetary 
system being some sort of gold coin. Other countries, like India, the 
Straits Settlement, the Philippine Islands, etc., are on what is techni- 
cally known as a “gold exchange ” basis,! which means in brief that 
their coins are exchangeable for a certain amount of foreign exchange 
payable at a fixed ratio in gold in some designated foreign center. 
Only a few countries, China being the most important, still remain 
on a silver basis. Some South American nations are on a paper money 
basis. Due to the exigencies of the war even the more important 
our foreign trade balance during the six and a half years from July 1, 1914, to December 31, 
1920. 


‘“‘A table showing items in our foreign trade balance between July 1, 1914, and December 
31, 1920, of known amounts follows: 


CREDIT 
Visible 
Exports oh merchandise. and. Sivers vc us.cay. oss eek $30,477,831,159 
Exports of Pold Oat eee ee eect cs ah tres clare ee 1,429,262,624 
———_-_——_—_ | $49,007, 008,708 
Invisible 
Interest received on government loans... ............0cceceeceeeece 437,340,431 
$41,344,443,214 
DEBIT 
Visible 
Imports of merchandise and silver..................+. $20,5 28,606,984 
Imports of old eee SiG alain tee Meer aete pe. cae 5k 2,259,323,817 
$22,787,930,801 
Invisible 
Government loans less repayments. ................02- $9,466,283,171 
Government purchases of foreign currency.............. 1,490,557,111 
Private Gang. fea es cot ie ee es «Pec dive dhs 1,080,717,727 
12,946,558,009 
$35,734,488,810 
Leaving a debit liquidated, by. other items Of)... rc. .05.. ts canes $5,609,954,404 


“ The last debit in the table consists of invisible items representing payments for services, 
etc., the amounts of which can only be estimated.” 
1 Cf. pp. 451-465. 


PRINCIPLES OF FOREIGN EXCHANGE 123 


European nations, which are normally on a gold basis, are at present 
(April, 1922) on a depreciated paper money standard. In spite of 
that fact, however, gold figures solely as the metal that is used in the 
settlement of trade balances between us and the latter nations be- 
cause we will not accept either paper money or silver in payment of 
their obligations to us.! 

If, when we sold goods to foreigners there were no bills of exchange, 
they would have to ship us precious metals, and when they sold goods 
to us we would have to ship precious metals to them, which would 
result in a great waste of effort and money. We have therefore de- 
vised ways and means through the use of bills of exchange whereby 
such shipments are made only when necessary to pay balances, or 
to put the exchange machinery back into its normal functioning 
condition, or to net a profit to exchange dealers. The fundamental 
principle upon which is based the practice of settling debts without 
the shipment of the precious metals is as follows: : 

Let us say that Jones in New York has bought some goods front 
Pratt in London equal in value to 1,000 ounces of gold. We will use 
ounces of gold in our illustration so as to obviate the necessity of 
dealing with pounds sterling and dollars. At the same time Smith 
in New York has sold goods, likewise valued at 1,000 ounces of gold, 
to Lloyd in London. Now, if it were possible for all of the parties to 
know each other personally, inasmuch as the amount of money that 
Jones of New York owes Pratt in London is the same as that which 
Smith of New York has coming to him from Lloyd of London, the 
whole transaction could be settled without any funds crossing the 
Atlantic Ocean by Pratt telling Jones to pay Smith 1,000 ounces of 
gold, and by Smith telling Lloyd to pay Pratt the same amount. Each 
buyer would thus pay the amount that he owed, and each seller would 
receive the amount that was due. Of course, such a situation could 
never arise, because the parties could not know each other and also 
because the sums to be paid and to be received would never be equal 
(Fig. 28). 

If the parties knew each other the claims of all parties might also 
be settled in the following manner: Smith in New York who has 
sold goods to Lloyd in London might draw a draft on Lloyd for the 
value of the goods and sell the same for 1,000 ounces of gold to Jones 
in New York who has to pay Pratt in London for the goods which 

1 Cf. Chapter XII. 


) 


124 DOMESTIC AND FOREIGN EXCHANGE 


he has bought from Pratt. Jones might then send the draft to Pratt, 
who would collect 1,000 ounces of gold from Lloyd. Thus by means 

of one draft, the claims 
of all parties against 
each other would be 
satisfactorily and com- 
pletely settled (Fig. 29). 





pus pane What actually hap- 
73th ree pens, however, is that a 
third party, a bank or 

an exchange dealer of 

SMU beac some sort, comes in be- 
FIGURE 28 tween the parties con- 


cerned and make the 
payments more easily 
possible. Smith of New York has sold goods to Lloyd of London; 
he draws a draft on Lloyd to the value of 1,000 ounces of gold 
and sells it to his bank. The bank in New York sends it to its 
correspondent in London, which collects it from Lloyd. To keep 
our example as simple as possible, let us say that Jones of New 
York, having purchased goods from Pratt of London, goes to 
Smith’s New York bank and buys a draft from it on its London, 
correspondent to the value of 1,000 ounces of gold. Jones mails 
the draft to Pratt. Pratt receives the draft in the mail and takes 
it to the bank upon which it has been drawn, and gets his money. 


By this means all parties 
es a 


concerned have paid their 
money that was due 
Sinith draws Pratt collects 


Diagram showing theory of foreign payments 






Ones SE! 


bills or have received the 
them, and no gold has DatartLo the droft 
crossed the Atlantic (Fig. eae came Tron playa 
30). 

The item of discount 
and the use of the terms 
“dollars” and “pounds 
sterling” have been pur- PIGUBE ay 
posely omitted from Diagram showing theory of foreign payments 
these preliminary explanations of the fundamental principles that 
underlie the workings of our foreign exchanges, so as to present the 


PRINCIPLES OF FOREIGN EXCHANGE 125 


situation in as simple a form as possible. As has been previously 
stated, American firms are continually exporting to and importing 
from various countries. To simplify the discussion somewhat, it is 
better to limit our illustration to England and the United States. 
American exporters draw drafts on English firms for the value of the 
goods that are sent abroad. The drafts are for all sorts of amounts, 


and also run for various 
lengths of time, i. e., Jones sends bank oroflto Pratt 





1 7 Jones buys a Pratt cojlects 
from sight to six months. pte ee rope pon 
American banks and 24 tondeg bank 
financial houses _ pur- iw 
chase these bills of ex- Fu a Le ho 
change and send them “Smith London bark 

- araws Wat or7 Qlects oft 
abroad for collection. Lloyd and sells to Srom Lloyg 
Rect | American honk 
lected, they are added to 


the foreign balances FIGURE 30 


which the banks and Diagram showing theory of foreign payments 
financial houses keep with their English correspondents. Those who 
have bills to pay in England come to these banks and financial 
houses and buy drafts with which to make such payments. These 
drafts are also drawn for any sum, and also for various lengths of 
time, but are usually payable at sight. They are mailed by the 
American purchasers to the English firms to which they owe money 
for goods bought, and these firms cash them at their own banks. 
The latter then present the drafts to the banks upon which they 
have been drawn, and the accounts of the American banks are 
debited, or decreased, by the sums which the drafts represent. The 
banks and financial houses act as the “go-betweens” that make 
such transactions possible. 

If we buy from English merchants more than we sell to them, there 
is a great demand for drafts on England, which tends to use up the 
accounts that the American banks have with their correspondents 
in England. This creates a scarcity of exchange on England, which 
tends to raise the rate of exchange to levels where it may become 
profitable to ship gold to England. On the other hand, if we sell to 
English merchants a much larger amount than we buy from them an 
over-supply of bills on England is created, which floods the bankers 
and exchange dealers with bills, and therefore tends to lower the rate 


126 DOMESTIC AND FOREIGN EXCHANGE 


of exchange to such a point that it may become profitable to import 
gold from that country.! Gold will not be shipped, however, unless 
it becomes necessary or profitable to do so. 

In any discussion of the exchanges, one must always keep clearly 
in mind the fact that banks (and from now on we shall use the word 
“banks” as referring to all financial houses that deal in foreign ex- 
change) act as both buyers and sellers of exchange. They buy so as 
to build up their foreign accounts against which to sell exchange of 
various sorts, and they sell to those who have to make remittances 
to foreign parties. Banks, therefore, have their buying and their 
selling rates of exchange. Naturally they aim to buy low and to sell 
high, or to put the matter in a slightly different form, they aim to sell 
at a slightly higher rate than that at which they have purchased in 
order to net a profit. Frequently, however, banks are compelled to 
take considerable losses owing to adverse fluctuations in exchange 
rates. 

Another matter which the beginner must not overlook is the long 
standing practice that when we buy goods from Englishmen they ex- 
pect us to buy a draft and to remit it to them, while when we sell goods 
to them they expect us to draw a draft on them and realize our money 
thereon by selling the draft to our banks. The result is that drafts 
remitted by American buyers and drafts drawn by American sellers 
both flow toward London. This is quite the practice in the case of all 
countries that trade with firms in England, although of course Eng- 
lish exporters at times do draw on the foreign buyer. Even the as- 
tounding developments of the World War have not as yet noticeably 
affected this long prevailing custom. ‘There are several reasons for 
the origin and retention of this practice. The American exporter 
prefers to draw his draft and to get his money immediately by selling 
his draft to the local bank, rather than to wait for a remittance to 
come to him from his English customer. American banks readily 
purchase these bills because there is always an excellent market for 
them in the discount market of England and also because they must 
have some means of building up their accounts in England against 
which to sell drafts to those who desire to remit funds to England or 
to other countries. On the other hand, the American importer much 
prefers to remit to his English creditor rather than to allow the latter 


1 The details of gold shipments and the reasons therefor will be more fully presented in 
Chapter XI. 


PRINCIPLES OF FOREIGN EXCHANGE 127 


to draw against him for the goods that the Englishman has purchased. 
If the American buyer remits, he knows exactly how many pounds 
sterling he owes the British firm, and he can get the best possible rate 
for sterling exchange from his local bank with which he has had busi- 
ness connections possibly for many years. Rates charged for ex- 
change are always “shaved” or decreased slightly in favor of a bank’s 
regular customer. Although the English firm has to wait for its 
money to arrive (in the form of a remittance), nevertheless, in making 
its prices to the American, it has taken care to include therein an 
interest charge that will compensate it for the time lost while waiting 
for the arrival of the funds. If the American did not remit, but al- 
lowed the English firm to draw on him, he would most likely have the 
draft presented to him for payment through a strange bank or broker 
who would not give him so favorable a rate as would his own banker. 
One very important reason for the development of the custom of our 
remitting to England is the fact that before the enactment of the 
Federal Reserve Law in 1913 there were no facilities in the United 
States for the discounting of drafts that arose out of our foreign trade. 
Therefore, if the English firms drew on American firms and sent their 
drafts to the United States for collection, the bills had to be held until 
maturity and could not be discounted in the open market. English 
merchants much preferred to get their money as soon as possible, so 
they demanded that we remit to them for goods purchased. 

The practices employed between American firms and firms in 
countries other than England ordinarily follow the custom of the 
exporter drawing a draft against the importer or against some bank 
with which the importer has arranged some form of credit. Thus 
when we export we usually draw a draft on the foreign importer or 
on a bank which he has designated, and when we import, the foreign 
exporter usually draws a draft on us or on some bank that we designate. 
The bank, in either case, may be in the country of the exporter or in 
that of the importer or it may even be in a third country. Paying 
for imports and exports through a bank as an intermediary will be 
discussed in Chapter IX. 

Normally we have in the market at all times large amounts of bills 
of various kinds drawn against foreign firms and banks and also 
against domestic firms and banks. Foreign exchange dealers daily 
traffic in these bills just as other merchants traffic in clothing, farm 
produce, raw materials, etc. Their stock in trade is, briefly, “claims 


128 DOMESTIC AND FOREIGN EXCHANGE 


to money in other countries.” Their customers either have a claim 
for money against some foreigner which claim they desire to sell to a 
bank in return for dollars, or else they owe some money to a foreigner 
and desire to buy from the bank, for dollars, a claim to funds abroad 
with which to settle their indebtedness. Only occasionally will a 
bank be called upon to buy or to sell the actual money, either paper 
or metal, of foreign countries, and only occasionally will even the 
very largest banks be in the market as buyers or sellers of gold or 
silver. It is “claims to money in other countries,” more commonly 
called “bills” or “bills of exchange,” with which the foreign exchange 
houses primarily concern themselves. 

These bills of exchange are drawn for the most part in the moneys 
of other countries. A small but increasing proportion is being drawn 
in terms of dollars. The foreign exchange dealer, therefore, must 
ever be ready to purchase or to sell foreign bills, but always in return 
for payment in the money of his own country. In other words, when 
an American draws a draft in pounds sterling, or francs, or marks, 
and sells it to his bank, the banker must translate the amount of 
foreign money, for which it has been drawn, into dollars. How much 
are the pounds or francs or marks worth in American money? Like- 
wise when an American goes to his bank and purchases a draft for a 
certain number of pounds sterling, francs, or marks, etc., he pays 
dollars for it, and the banker is compelled to translate the value of 
that amount of foreign money into dollars and cents. This translat- 
ing of the value of one nation’s money into the money of another is 
technically known as “conversion” and will be more fully discussed 
when we come to a description of the methods and calculations in- 
volved in the actual buying and selling of bills of exchange.'! In the 
early years of foreign trade and travel before the use of credit instru- 
ments developed, the money changer played an important part, 
sitting in the market place and exchanging the money of his own 
country for that of the traveler from foreign lands. Today the ex- 
change department of a bank performs the same service, except that 
for the most part it deals in credit instruments, in bills of exchange, 
in claims for money, rather than in the actual paper or metallic money 
of foreign countries. But the clerks in that department are still com- 
pelled, as were the money changers of old, to convert the money of one 
country into terms of the money of another. At times, travelers 

1Cf. Appendix III. 


PRINCIPLES OF FOREIGN EXCHANGE 129 


do come to the exchange department with small sums of foreign 
monies which they desire to sell to the bank, i. e., to have converted 
into the money of the United States. It is then that the exchange 
department becomes an old-fashioned money changer, and the clerk 
looks up his list of rates for foreign monies, supplied weekly by some 
large New York dealer, and sets the price at which he will exchange 
American money for the foreign (Fig. 31). 














Guezae Brees. “eustets 





3130 CABLE ADDRESS: 
| 38: 
panower 2s _ FOREIGN DIONEY «xp FOREIGN EXCHANGE eentes 
S38 BULLION AND SPECIE : manccuia wiseteae” 
644 FOREIGN & UNITED STATES GOVERNMENT BONDS : ce ETRE RE Seo 5 austen) 
se BROKERS IN FOREION EXCHANGE ei ee ee al 
WIRES 52 WALL STREET,NEW YORK oo 
BUYERS Rates Sulject to fluctuation = SELLERS 
A *NOTES #iGOLO SILVER aaa as oe é 
HATS : ee APRIL 21th. 1922, ae 
Africa 80. 4.35 4,95 216 «32s éAustrian -000160 
Aigeria  — . 08% -1915 08 204 Bulgarian O01 
Arzontine 535: 4.80 +35 220 Czecho -0210 
Austria -00012 -1978 = .07$ = «. 0008 English | 4.46 
Australia 4.26 4,82 +164 ait Finnish .02t 
Balgium . 0836 1915 = .08 206 French e =  .0945 
Bolivia 20. 8.75 «40 . German e 20039 
~ Brazil +133 +54 4i5 +08 bs Greek se i 0420 
British W.I. .88 £ * Hungarian oe .OO15 - 
Sulgaria -0060 o1915 207% 0005 Italian Currency 6.50 
Canada (‘iéié«wt‘ TH 98h 964 .85 “ Stamps (80 Centesimi) 6, 
China 61 245 “* (20 | *. ) 6. 
Chile +10 »35t +08 «05 Polish - 0003 
Colombia +86 4,82 60 “45 Portuguese : oil. 
Coste Rica .19 45 +30 10 |. Roumanian 20082 
Juba +98h. .88 «75 Russian 500s 00075 
G2zecho +0190 : 02 Servian +02 
Denmark . eek 264 eel 14 CAMBIALI & CARTA BOLLATA, 
Szypt 4,45 4.90 212 12 : FOREIGN BONDS. 
f&ngland 4.42 4,84 4,37 Be he Austrian Treas 6s 6225: 
Finland O18 -  ah916 08 -O2 1917 4s French Nat. 62.00 
Prance .09324 -1920 08% +07 1931- Ss Victory 73.50 
Germany - 0036 +2360 elG = = 1008 - 4920 = 6s Frenoh Nat. 87.50 
Gibraltar 4.30 : German Gov. =5s - 3.25 
Brasce SRS ce yawn NA : Oaetin BAe * ae ; , 
FIGURE 31 


Typical list of foreign money prices 


The “rate of exchange” is the price that the buyer has to pay for 
the particular kind of foreign exchange that he is purchasing. When a 
traveler from a foreign country asks the clerk in the exchange de- 
partment, “How much will you give me for the foreign coins that I 
have brought over with me,” the rate is the amount of American 
money that the clerk will give him for his foreign coins. The rate 
that will be paid for a foreign bill on the traveler’s country may be 
greatly different from the rate that he will get for his foreign coins or 


130 DOMESTIC AND FOREIGN EXCHANGE 


paper money. In normal times there is a rather close relationship 
between the two, but in abnormal periods they may be widely apart. 
In the case of the coins themselves the amount given will be some- 
where near the value that we place on their gold or silver content, 
i. e., the value of the gold or silver bullion which they contain. This 
is because the coins may be melted and sold as so much bullion in 
our home markets. Gold coins will be bought usually at a discount 
of from 1 to 114 percent. The value of foreign paper money, naturally, 
fluctuates much more widely than the value of foreign coins because 
it is of no value to us in our own country unless we can find some per- 
son who is willing to buy it, either as a dealer or speculator, or as a 
prospective traveler in the country concerned. During the past few 
years a considerable amount of foreign bank notes has passed through 
the hands of American banks which have purchased them usually at 
their buying rates for demand drafts less cost of insurance, which 
differs with the country, but which has ranged from % per cent to 1 
percent. 

Inasmuch as there are different monetary systems in different 
countries, there must be some basis used upon which to make calcu- 
lations as to the value of the money of one country in terms of that 
of another. The basis of the rate of exchange on foreign countries 
(and in the rest of this volume we shall use the term “exchange rate” 
as applying solely to the price paid or charged for foreign bills of ex- 
change) is what is technically known as “the mint par of exchange,” 
more commonly as the ‘‘par of exchange.” This par of exchange is 
obtained by comparing the relative weight and fineness of the precious 
metal contained in the standard coin of the respective countries con- 
cerned. The standard coin of a country is the unit or basis of its 
monetary system, in terms of which all things are valued in that 
country. There can be a mint par between countries that have a gold 
coin of any sort as their standard coin, but as between a gold standard 
country and a silver standard country there can be no mint par be- 
cause there is no fixed ratio between the value of gold and silver. The 
value of silver in terms of gold fluctuates continually, making a fixed 
basis of comparison impossible. Nor can there be a mint par of ex- 
change between paper standard countries themselves, nor between 
them and gold or silver standard countries, because, again, there is 
no fixed relationship between the value of the paper money of one 
country in terms of the paper money of another, or in terms of either 


PRINCIPLES OF FOREIGN EXCHANGE 131 


the gold or silver money of another. Thus a mint par of exchange, 
or aS we more commonly say, a par of exchange, exists between the 
United States and only those countries which have a gold coin as 
their standard, or measuring rod, of value, or more technically, as 
the basis of their monetary systems. As between the United States 
and silver or paper standard countries there can be no par of exchange. 
The paper and silver exchanges as well as the exchange relations with 
the so-called “gold exchange standard” countries will be discussed 
in Chapter XII. 

There is considerable difference between the weight of the various 
gold coins which have been adopted by the more important countries 
of the world as the bases of their monetary standards, although their 
fineness is almost universally the same, i. e., 9/10 fine. Our own 
gold coins are 9/ro fine, i. e., they contain nine parts of pure gold 
to one part of alloy, the alloy being used for the purpose of hardening 
the metal and making it more capable of resisting wear and consequent 
loss in weight from constant handling. The same is true of the gold 
coins of France, Germany, Italy, Belgium, Switzerland, and practi- 
cally all of the other trading countries. The one notable exception 
is England whose gold coins are 11/12 fine. To obtain the par of ex- 
change as between countries on the same monetary standard, it is only 
necessary, therefore, to compare the weight of the pure metal in the 
standard coin of one country with the weight of the pure metal in 
the standard coin of another. As between the United States and Eng- 
land, we find the following: Our gold dollar, though no longer minted, 
is by law decreed to be 23.22 grains of pure gold.1 The English 
sovereign contains 113.0015 grains of pure gold.” Dividing the latter 
by the former we find that the pure gold content of the English sover- 
eign is 4.8665-+ times as great as that of the American dollar. There- 
fore we say that the par of exchange between the United States and 
England is $4.8665-+, which is the value of the pure gold in the sover- 
eign as measured in terms of the value of the pure gold in the Amer- 
ican dollar. 

The smallest French gold coin minted is the five franc piece, which 
contains a total of 24.8908 grains 9/1o fine, or a content of 22.4018 
grains of pure gold. Thus the pure gold in the five franc piece is 
worth $.9647 of our money; a franc being one-fifth of that amount, the 


1 Being nine-tenths fine, it has a gross or total weight of 25.8 grains. 
2 Being eleven-twelfths fine it has a gross or total weight of 123.2744 grains. 


rea DOMESTIC AND FOREIGN EXCHANGE 


mint par between the United States and France is $.19295. Inasmuch 
as Italy, Belgium, Spain, Switzerland, Greece, Bulgaria, Serbia, Fin- 
land, Venezuela, and certain other countries have as their standard 
of value a gold coin of the same weight as the franc (known 
respectively as the lira, franc, peseta, franc, drachma, lev, dinar, 
markka and bolivar), the par of exchange between the United 
States and those countries is the same as that for France, i. e., 
$.19295. 

The German crown of ten marks contains 61.4588 grains of gold 
g/ro fine, or a pure gold content of 55.3130 grains. Valued in terms 
of the American dollar it is worth $2.3821, which gives a mint par 
per mark of $.23821. The par of exchange in terms of the pound 
sterling between England and Germany is 20.429 marks (commonly 
known as 20.43), while between England and France it is 25.2215 
francs (commonly known as 25.22). Between England and those 
other countries that use the same weight gold standard coin as France, 
the par of exchange is naturally the same as that between England 
and France, viz., on Greece, 25.2215 drachmas; on Belgium, or 
Switzerland, 25.2215 francs; on Italy, 25.2215 lira; on Spain, 25.2215 
pesetas, etc. Between Germany and France, the par of exchange 
of the mark is 1.2345 francs. It must not be overlooked that in the 
examples just given we have quoted the par of exchange in only one 
direction. For example the mint par of the mark in terms of francs 
is 1.2345 francs, but the mint par of the franc in terms of the mark 
is approximately .81 marks (to be exact, .8099 marks). The mint 
par of the mark, the franc, and the dollar in English money is respec- 
tively 11.747 pence, 9.515 pence, and 49.316 pence or 4 shillings 
1 5/16 pence. 

As between countries that have as their standard a coin of the same 
metal, weight, and fineness, the par is found without any calculation 
being necessary. The Dominion of Canada has, as its standard coin, 
the gold dollar of the same weight and fineness as that of the United 
States. The mint par is therefore one American dollar for one Cana- 
dian dollar or vice versa. Rates of exchange between Canada and 
the United States fluctuate above and below par just as do the rates 
of exchange between the United States, England, France, or any 
other country, depending upon certain factors to be later considered.? 

The pars of exchange for gold standard countries as estimated 

1See Chapter X, Rates of Exchange. 


PRINCIPLES OF FOREIGN EXCHANGE 133 


by the Director of the United States Mint appear in Ap- 
pendix II.! 

The mint par expresses only the ratio between the weights of the 
standard coins of two countries as they are supposed to be minted, 
not the ratio between their weights as they are found in actual cir- 
culation. If a comparison were made between the weight of £10,000 
of English gold coin and $48,665 of American gold coin actually in 
circulation, the ratio would be different from the mint ratio because 
of loss by abrasion, or because the minting had not been perfect as 
to weight or as to fineness, or both. As Clare so aptly says, “The 
Mint Par depends, in short, not on the coin itself, but on the Jegal 
definition of it; not on the sovereign de facto, but on the sovereign de 
jure; and if every gold coin in this country were debased, and every 
gold coin in France sweated and mutilated, the Mint Par would still 
remain the same. Unless and until the law is altered the Mint Par 
cannot alter.” ” 

While the market rates of exchange on a country are continually 
fluctuating above or below the par of exchange, the par itself never 
changes unless the country itself modifies the metallic content of its 
standard coin. This has occurred many times in the past as monetary 
systems have been revised, and naturally necessitates a change not 
only in the mint par of exchange but also at times in the method em- 
ployed in quoting the exchanges. In the case of our own country 
we have from time to time varied the weight and fineness of our stand- 
ard gold coin and have likewise changed our methods of quoting ex- 
changes on other countries. In our early history the value of foreign 
monies was quoted in terms of the Spanish dollar, which was then 
the current standard, the par of the pound sterling being fixed at $4.44 
by Congress by Act of July 31, 1789. The law creating our mon- 
etary system (April 2, 1792) decreed that the ten dollar gold piece 
should have a total or gross weight of 270 grains of gold 11/12 fine. 
This made the pound sterling worth about $4.5614. The law of June 
28, 1834, reduced the gross weight of the ten dollar gold piece to 258 
grains, still 11/12 fine, making the pound sterling worth about $4.78. 
On Jan. 18, 1837, the fineness of our gold coins was reduced to g/ro, 
changing the par of the pound to $4.8665-++ where it still remains. 


1The Director of the United States Mint estimates quarterly the par of exchange be- 
tween the United States and all gold standard or gold exchange standard countries so that 
the value of foreign merchandise entering the country may be properly estimated. 
2‘“*The A. B. C. of the Foreign Exchanges,” p. 21. 


134 DOMESTIC AND FOREIGN EXCHANGE 


Up to 1834 the English valued our dollar as being worth almost exactly 
4 shillings 6 pence, which they called 100 or par, and we quoted the dol- 
lar, as they did, as being either above or below par. However, when it 
was above par for England it was below par for us. Thus if the quota- 
tion were to appear as “Pound sterling—108 1/8” in England it would 
signify that the pound sterling commanded a premium of 8 1/8 per 
cent or that it would purchase 8 1/8 per cent more American money 
than if it had remained at par. With us, conversely, it meant that 
our dollar was at a discount of 8 1/8 per cent, because at 108 1/8 
it would take more American dollars to buy a fixed sum of English 
money than if the quotation were at 100. From 1834 to January 1, 
1874, during which time we made the change in our monetary system 
above referred to, the London Stock Exchange continued to value 
the American dollar for trading purposes at 4 shillings 6 pence, which 
was from g to 9 1/2 per cent too high, so that in the field of exchange 
the accepted par was raised to 109.45 5/8, which par was adopted 
by the New York bankers. On March 3, 1873, however, Congress 
fixed the par of exchange of the pound sterling at $4.8665 and in pur- 
suance of that law the method of quoting sterling was altered, the 
present system going into effect January 1, 1874. 

We have also changed our methods of quoting other exchanges. 
Until 1920 we quoted German exchange on the basis of how much 
four marks were worth in American money, while French exchange 
was quoted on the basis of how many francs the dollar would buy. 
Since 1920, however, we have changed to the basis of quoting what 
the mark or the franc is worth in American money, i. e., how many 
cents it takes to buy a mark or a franc. 

The exchanges become “favorable” or “unfavorable,” in accord- 
ance with the nature of their fluctuation. If our own money becomes 
more valuable as measured in terms of the foreign money, or, more 
accurately, if our dollar will purchase more pounds, francs, marks, 
etc., the exchanges are said to be “for us,” or are “favorable.” If 
our money will buy less foreign money, the exchanges are said to be 
“against us,” or “unfavorable.” When exchanges are “favorable,” 
rates have moved toward the point at which gold will tend to be 
shipped into our country. This will build up our bank reserves and 
will tend to make money “easier”? or cheaper in the United States, 


>) 


1 Our former system of quoting marks and francs will be more fully described in Chap- 
ter X. 


PRINCIPLES OF FOREIGN EXCHANGE 135 


thereby enabling borrowers to secure loans and discounts from their 
banks at lower rates. When the exchanges are “unfavorable,” rates 
have moved toward the point at which gold will tend to leave the 
country, and if gold does leave it will reduce bank reserves and cause 
money to become “tighter”? with the result that the rates charged 
by banks for loans and discounts will tend to be increased. 

Another expression “the commercial par of exchange” is found 
at times in text-books and sometimes in our financial journals. The 
more customary statement is that ‘‘the exchanges are at par,’ which 
signifies that our financial claims on another country are equal to its 
claims on us. Of course such a situation could but rarely if ever occur. 
As will be noted later it is the inequality of claims that to a very great 
extent causes exchange rates to fluctuate above and below par. 

In publications and articles dealing with the exchanges and also 
in current discussion among exchange dealers themselves, such terms 
as “dollar exchange,’ “sterling” or “sterling exchange,” “the Con- 
tinental exchanges,” “neutral exchanges,” “Eastern” or “Oriental 
exchanges,” “South American exchanges,” “silver exchanges’ and 
“paper exchanges” are commonly met with. “Dollar exchange”’ is 
exchange drawn in terms of dollars. American exporters now draw 
a large number of bills on foreign firms in dollars; importers also 
frequently ask that the bills drawn on them by foreigners be drawn 
in dollars; travelers, both for pleasure and for commercial purposes, 
take dollar letters of credit abroad, and banks that are members of the 
Federal Reserve System are authorized, under restrictions imposed 
by the Federal Reserve Board, to establish dollar exchange in the 
United States for the use of foreign banks “as required by the usages 
of trade in the respective countries.” | 


1The Federal Reserve Law permits ‘‘any member bank to accept drafts or bills of ex- 
change drawn upon it having not more than three months’ sight to run, exclusive of days 
of grace, drawn under regulations” . .. prescribed by the Federal Reserve Board, by 
banks or bankers in foreign countries or dependencies or insular possessions of the United 
States for the purpose of furnishing dollar exchange as required by the usages of trade in 
the respective countries, dependencies, or insular possessions (Sixth Annual Report [ror9], 
Federal Reserve Board, p. 21). 

The purpose of the act and the regulations adopted thereunder by the Federal Reserve 
Board is to provide dollar exchange in countries where the sight draft or cable “‘is not the 
current means of remittance in payment of foreign debts, but where the three months’ 
bankers’ draft is generally used for that purpose.” 

The Board has ruled that there is nothing ‘“‘in the provisions of Section 13 of the Federal 
Reserve Act which can be construed to permit the acceptance by member banks of drafts 
drawn merely for the purpose of correcting adverse exchange conditions,” or ‘‘merely 
because dollar exchange is at a premium in the country where the drafts are to be drawn.” 

The countries designated thus far (April, 1922) are: Australia, New Zealand, and other 


136 DOMESTIC AND FOREIGN EXCHANGE 


“Sterling exchange” means exchange on England. The “Conti- 
nental exchanges” refer to the exchanges of the countries of the Eu- 
ropean continent. “Neutral exchanges” is a term that is already 
passing out of use, and arose during the World War to designate the 
exchanges on the then neutral nations. The term “Eastern” or 
“Oriental” exchanges applies to the exchanges on Oriental countries 
including India; “South American exchanges” to the exchanges on 
South American countries; “silver exchanges” to the exchanges on 
silver standard countries; and “paper exchanges” to the exchanges 
on paper standard countries. 

The methods followed in quoting the rates on various countries, 
the system by which the rates progress or advance, the factors affect- 
ing the actual rates charged or paid, will be considered in detail in 
Chapter X. It is sufficient for our present purpose to have learned 
the meaning of certain technical terms commonly employed in the 
open market and in the discussion of the exchanges. 

Australasian dependencies, Argentina, Australia, Bolivia, Brazil, British Guiana, British 
Honduras, Chile, Colombia, Costa Rica, Cuba, Dutch Guiana, Ecuador, French Guiana, 


Guatemala, Honduras, Nicaragua, Panama, Paraguay, Peru, Porto Rica, San Salvador, 
Santo Domingo, Trinidad, Uruguay, Venezuela, and the French West Indies. 


CHAPTER VII 
FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 


Foreign bills of exchange are very much like domestic bills of ex- 
change, the main differences being that, first, the personal bank check 
drawn in dollars as we know it in domestic trade is never used; second, 
the draft drawn by the seller upon the buyer, viz., the ordinary trade 
acceptance, is very seldom found, although now and then it appears 
for reasons later to be discussed; and third, bills of all kinds, even in 
spite of the developments during the World War, are still for the most 
part drawn in terms of a foreign money, although as has been noted 
there appears to be a growing tendency to finance our foreign trade 
by means of “dollar exchange.”” Foreign exchange stresses the part 
played by banks and other financial intermediaries even more than 
does domestic exchange. 

Practically all foreign trade is financed by means of drafts of some 
sort or other and cables, although of late there has been a slight 
development in the use of the ordinary bank check drawn by American 
importers in terms of foreign money against checking accounts which 
they have established with foreign banks. Cables, or telegraphic 
transfers (commonly designated as “T. T.” in the foreign exchange 
lists), are payable immediately upon receipt by the foreign corre- 
spondent to whom the cable is sent. Foreign drafts, however, may 
be payable at sight, i. e., on presentation to the payer or the party 
upon whom drawn (commonly called “sight”? or “demand” bills), 
or at so many days after sight, i. e., so many days after the draft has 
been presented for acceptance (commonly called “time”? bills), or at 
so many days from date, i. e., so many days from the date on which 
the draft was drawn (commonly called “date” bills). Days of grace 
do not run in the case of sight bills or cables, but they do hold in the 
case of time bills and date bills, the number of days of grace varying 
as between different countries. Days of grace are not allowed by 
European countries as a rule; Great Britain, the most noteworthy 
exception, allows three days grace. A sixty days draft on London 
reaches maturity and is payable, not at the end of sixty days, but at 


137 


138 DOMESTIC AND FOREIGN EXCHANGE 


the end of sixty-three days. Short time bills may run three,’ seven, 
ten, or thirty days from sight. Many-of the shipments sent to Ger- 
many from the United States since the World War have been covered 
by three day sight drafts. Had the drafts been drawn at sight, it 
might have been difficult for the German importer to have paid the 
draft on demand, but being allowed three days time in which to make 
the necessary arrangements with his bank he could much more easily 
make provision for the payment. Long time bills usually run sixty 
or ninety days from sight, although some run as long as six or nine 
months. Date bills drawn in New York on London or nearby Eu- 
ropean cities frequently run “ten days from date,” due to the fact 
that it normally takes about ten days for a cargo to reach those centers. 
Such drafts arrive a few days before the goods and before date of 
payment, but the time that intervenes makes it possible for the im- 
porter to get the funds needed for payment. If the draft were drawn 
at sight, it would necessitate payment by the importer before the goods 
were received.. Importers as a rule do not wish to pay for goods before 
they are at hand. Date bills may run for longer periods, i. e., thirty, 
sixty, or ninety days. There has been a growing desire on the part 
of the exporters to use the date bill rather than the long sight bill, 
because the former enables them to know exactly when the bill will 
mature and become payable, while if it is drawn so many days from 
sight the exporter cannot know definitely just when it is to mature 
unless the foreign correspondent advises him of the date of acceptance 
by the drawee. Importers, however, object to the use of the date bill 
because they feel that the bill is running against them during the 
days that it is in transit, and that consequently they have a shorter 
time in which to make payment than would be the case if the draft 
were drawn payable a certain number of days after sight. 

Drafts drawn payable at sight and date bills do not have to be 
accepted by the drawee as do bills drawn payable a certain number 
of days after sight. The latter, commonly known as “acceptance 
bills” or “acceptances,” are used in one form or another for the finan- 
cing of the greater part of our foreign trade. Acceptances that arise 
out of foreign trade may be classified on the basis of whether or not 
they are used in paying for exports (“‘export acceptances’’), in paying 
for imports (“import acceptances”), or in the loaning of money by a 
foreign bank to or through a domestic bank by means of the latter 


1In England a three day bill is not classed as a time bill. 


* FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE = 139 


drawing drafts against the former (generally known as “finance bills,”’ 
sometimes as dollar, sterling, mark, or franc loans). Acceptances in 
the foreign field may also be classified into trade acceptances and 
bank, or bankers’, acceptances. Each of the above forms of accept- 
ance bills will be discussed in subsequent pages. 

Foreign bills of exchange may be either “clean” or “documentary.” 
A clean bill has no documents attached relating to the nature of the 
transaction that brought it into existence. A foreign postal money 
order, a draft drawn by one bank upon another or by one merchant 
upon another merchant or by a merchant upon a bank, or a check 
drawn by an American upon his account with a foreign bank, are all 
instances of clean bills of exchange. They may be sent by the re- 
mitter for the purpose of enabling him to pay for goods, services, se- 
curities, etc., already purchased or about to be purchased abroad, or 
for the purpose of remitting funds to friends, relatives, etc., or they 
may be drawn by an exporting firm in order to obtain payment for 
goods that have been, are being, or are about to be, shipped abroad. 
Such bills are usually sight bills, although they may run from sight to 
sixty or ninety days. When a “clean” bill has been drawn by one 
merchant upon another, the bank or exchange dealer purchasing it 
takes a greater risk than usual because the dealer has no security 
except the credit of the drawer. The goods, payment for which is 
represented by the draft, may have been shipped some months before 
the draft was drawn. Or it may be that the clean bill is not based 
on a shipment of goods but arises in some other connection. The 
dealer who purchases a clean bill knows nothing of the details of the 
transaction which brought it into being. It is because of these facts 
that clean bills drawn by one merchant upon another are either not 
bought at all by some banks, or when purchased are paid for at a 
slightly lower rate than is given for documentary bills. Drafts drawn 
by a domestic bank upon a foreign bank, or by a merchant upon a 
bank under proper authorization, do not have to meet the above 
mentioned objections because of the unquestioned credit standing 
of the parties concerned, although, as we shall see later, when one bank 
draws too many drafts on another bank for the purpose of creating 
“finance bills,”’ the market will even in that case question the worth of 
the bills and will pay a little lower rate for them. 

Documentary bills of exchange, also known as “commercial bills” 
or “collateral bills,” are those which have negotiable documents 


I40 DOMESTIC AND FOREIGN EXCHANGE 


attached to the draft, which documents cover the goods that are being 
shipped.! The usual documents are the bill of lading, invoice, and 
insurance policy or insurance certificate. The invoice is a statement 
of the character and amount of the goods shipped, their prices, and any 
additional charges that may be involved. The bill of lading is, briefly, 
a receipt from the shipping company, and if made out to order and 
indorsed in blank, gives possession of the goods to the party holding it. 
The insurance policy or insurance certificate represents Insurance 
coverage for the goods, and, if in proper form and indorsed in blank, 
awards the insurance money in case of loss to the party that has 
possession of it. Each of these documents, as well as others that are 
used under certain conditions, will be more fully discussed later. The 
number and kinds of documents that are to accompany the draft, the 
manner in which they are to be drawn and to whom payable, the length 
of time for which the draft is to run (its “‘usance’’), interest charges, 
exchange, and all other matters relating to the shipment of the goods, 
are as a rule fully and completely determined between seller and buyer 
before the goods are shipped. “In export trade no detail of a trans- 
action should be left vague or undefined. Customers are far distant, 
mails are slow, cables are costly, and misunderstandings are exasper- 
ating and difficult to straighten out. A clear-cut agreement should 
be reached between buyer and seller as to the way the goods are to be 
packed and marked, who is to insure them and pay various charges, 
such as consular fees and other incidentals. The parties to the trans- 
action should assure themselves that they fully understand each other 
when using such trade terms as F. O. B., F. A. S. and so on, and attach 
precisely the same meaning to these commercial formulas.” ? It is 
necessary that the exporter abide by the terms of the contract of sale, 
otherwise when the goods and documents arrive at their destination 
the drawee may refuse to accept the draft and thus cause serious loss 
to the shipper. When a bank buys a bill of exchange, regardless of 
whether or not it is clean or documentary, or when it takes a bill for 
collection, it must always be careful to note that any instructions that 
are attached to the bill accord with the agreement between the drawer 


1‘ Documentary bills are those to which are attached negotiable shipping documents 
which not only constitute the evidence of the shipment but which also carry the right 
ultimately to control the goods. Of course the documents must be negotiable, otherwise 
the bill is practically a clean bill.” Agger, E. E., in National City Bank Correspondence 
Course in Foreign Exchange. 

2‘ Essentials of Trading with Latin America,” pamphlet issued by Guaranty Trust 
Company, N. Y., pp. 9-10. 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE § 141 


January 2, 


GUARANTY TRUST COMPANY OF NEW YORK, 
140 Broadway; New York City 


Dear Sirs: 


+ 


We enclose for the undermentioned draft with documents as enumerated. 


Collection 
The surrender of documents to drawees is conditional upon fulfithment. of instructions as 


indicated by cross (x) in margin. 
a eS Dee 
DRAFT NUMBER DOCUMENTS 


No. Commercial Invoice 
Drawer John Brown & Co. Consular Invoice 
Drawee Chinese Trading Co. Bills of Lading 

City Where Payable Shanghai, China Insurance Certificate 
Date Aug. 7, 1920. Certificate of Origin 
“Amount U. S. $10,342.10 Weight Certificate 
Drawn: at 120 d/d Declaration of Shipper 


INSTRUCTIONS 


z vn + 


Acceptance. 
Non-Payment 
A stacbcmaihen aoe 


x 


& Permit Drawee privilege inspecting merchandise before accepting draft, 


& Documents against 


& Protest for 


& Hold for arrival of goods. 
& Payable at collecting banks selling shes a 2 rate on New York day of payment. 
{ Payable at Check rate on New York, remitting proceeds by cable. charges for our account. 


&) Interest to be collected at .....% from date of issue until approximate arrival cover 
in New York. 


& Allow Drawee interest at......2 % per annum for anticipated payment. 


{ All charges are for account of 
Drawee. 


{ Waive charges if refused by Drawee. 


& In caee of need refer to_American Export Co. Shanghai _ 


and advise immediately by 


{ SPECIAL INSTRUCTIONS. 


Kindly collect this draft through the Asia Banking Corporatio, Shanghai. 


Yours truly, 





J. BROWN & Co. 


FicuRE 32—Instructions accompanying a foreign bill of exchange 


142 DOMESTIC AND FOREIGN EXCHANGE 


and the drawee covering the terms of the transaction, usually to be 
found in the commercial letter of credit ! or other document which 
forms the basis of the transaction. If it is a documentary bill of ex- 
change, the bank must be certain that the correct number of docu- 
ments accompany the draft, that they are of the designated kind, that 
full instructions accompany the bill as to how the documents are to be 
PIM Te Lee handled by its foreign 
ORIGINAL correspondent, i. ¢., 
Ohe American National Bank | whether they are to be 
of Sen Franriaco, Cal. turned over to the 
INSTRUCTIONS | DOCUMENTS ATTACHED drawee on payment or 
PERTAINING TO 
REMITTANCE No. MSA As ae on acceptance of the 
draft, and that all other 
conditions are fully pro- 
CONSULAR So ice vided for. In addition 
CERTIFICATES to the instructions 
Saris ont KEine which the drawer may 
give the bank when he 
places the bill in its 
hands, the bank itself 
DELIVER DOCUMENTS. AGAINST may impose certain con- 
IN CASE OF NEED APPLY TO____ 2 ditions or add other 
instructions. ‘These in- 
structions may be a 
typewritten set of di- 
“rections, or a_ small 
printed blank with the 
spaces properly filled in, 
or they may appear on 
the draft itself or on a detachable stub at the left end of the draft. 
Figures 32-33 are samples of forms commonly used to convey the 
necessary instructions to the foreign correspondent. 

These instructions are drawn in duplicate, sometimes in greater 
number, one copy always accompanying each complete set of docu- 
ments. When a number of bills are forwarded at the same time it is 
customary for the bank to send instructions regarding them on one 
blank, rather than to attach a separate list of instructions to each set 


INVOICES 


INSURANCE POLICIES 





FIGURE 33 


Instructions accompanying a foreign bill of 
exchange 


1Cf. Chapter. IX 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE — 143 


of documents. In that case the following form (Fig. 34) may be used, 
the terms of which will be explained later: ! 


AMERICAN NATIONAL BANK OF SAN FRANCISCO 


oe 


CABLE ADDAEeS: 
“AMERICAN” 


coerce veto : Gan FraNcigcoO, CAL. 


———<—$—$ $$$ 
WE ENCLOSE HEREWITH FOR poi aees eS Se. 
PROGEEDS: TO SE PLACED TO OUR CACO eee ; 





AgePectr 
AMERICAN NATIONAL BANK 


OF GAN FRANCISCO 





OUPLICATE 


FIGURE 34 
Instructions accompanying several bills of exchange 


The draft accompanying each set of documents may be drawn by 
a merchant (the exporter) against another merchant (the importer), 
or by a merchant (the exporter) against a bank with which the foreign 
importer or possibly his bank has made the necessary arrangements.” 
Long bills running from sixty to ninety days are usually, though not 
always, documentary in character. Documentary bills drawn against 
shipments of cotton, wheat, corn, and other staples, constitute the bulk 
of the bills dealt in by the New York exchange market. If the docu- 
mentary bills are demand (sight) bills, there is of course no need of 
acceptance by the drawee; he gets his documents and his goods only 
-upon the payment of the draft when presented to him. In case the 
draft is to run a certain number of days after sight, the documentary 
bill must be accepted and thus is classed as an “acceptance” bill. If 
drawn by one merchant against another it is a trade acceptance; if 
by a merchant on a foreign bank, it is a bank or banker’s acceptance. 
Whether or not the documents will be turned over to the drawee upon 
his having accepted the draft will depend entirely upon the instructions 
which accompany the draft. If the instructions are that the docu- 


1Cf. pp. 159-1609. 
2 See discussion of foreign commercial letters of credit, Chapter [X. 


144 DOMESTIC AND FOREIGN EXCHANGE 


ments are to be turned over to him upon acceptance, the drawee re- 
ceives them immediately upon acceptance. Whether or not he must 
deposit security with the bank or agent who presents the draft to him 
for acceptance will also depend upon the instructions which the 
foreign correspondent has received and which accompany the docu- 
ments. In the case just described, the instructions would read “ Docu- 
ments on acceptance,” or merely “D. A.” If the drawer did not wish 
to have the documents turned over to the drawee upon acceptance 
but only after he has paid for the goods, the instructions would read 
“Documents on payment,” or merely “D. P.” Acceptance does 
not always give possession of the documents or of the goods. In the 
latter case, where the instructions are “D. P.”, the act of accepting 
merely sets the date from which the draft begins to run. The ac- 
ceptor of a “D. P.” bill is able to obtain his documents and his goods 
only after he has paid the draft. He is permitted to pay it any time 
between the date of his acceptance and the date of the maturity of the 
bill. In England, if the draft runs for sixty days, he may wait until 
sixty-three days (three days of grace being allowed) have elapsed before 
being compelled to pay the bill and before getting his documents, 
but he may pay it any time after acceptance. If he pays before 
maturity, he is given a “rebate,” i. e., he pays less than the face value 
of the draft, the amount of his rebate depending upon the discount 
rate in the market and the number of days the bill is paid ahead of 
time. “D. P.” bills are therefore usually known as “rebatable com- 
mercial long bills.’”’ The rate of the rebate, sometimes called the “re- 
bate rate,” or ‘‘the rebate rate of interest,’ but more correctly the 
“retirement rate of discount,” is fixed by custom in England at one- 
half of one per cent above the rate of interest that bankers are paying 
for deposits (usually two per cent under the Bank of England’s official 
rate of discount), or, to put the matter another way, the retirement 
rate of discount is usually one and one-half per cent below the Bank 
of England’s discount rate. In other European centers the retirement 
rate of discount is usually fixed at the current rate of discount of the 
central bank of the country upon which the draft has been drawn, 
It is an unusual thing for an acceptor of a “D. A” bill to be willing to 
pay the draft before it is due. If, however, he does pay it before 
maturity, he is given a rebate at the same rate as for “D. P”’ bills. 
When a “D. A.” bill has been accepted and the documents have 
been handed to the acceptor, the documentary bill becomes a clean 


' 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 145 


bill, nothing but the draft remaining in the hands of the correspondent. 
This draft may then be indorsed by the holder and discounted in the 
open market. There is no need of keeping track of the bill as it passes 
from one party to another, because the person who holds it on the 
date of maturity will either present it or have his bank present it to 
the acceptor for payment. “D.P.” bills are not discounted in England, 
for the simple reason that the acceptor may at any time wish to pay the 
draft and thereupon obtain his documents so as to have access to his 
goods. If the bill were discounted and possibly rediscounted a 
number of times, it would be difficult for him to trace it from bank 
to bank and locate the person or bank that was holding it. The holder 
of a number of “D. P.” bills, however, may use them as a pledge for 
a loan, with the agreement, however, that the acceptor may have 
his documents whenever he is willing to pay the draft and that other 
bills may be substituted for those that are taken up by the acceptor be- 
fore the maturity of the loan. In Germany, however, it is not unusual 
for “D. P.” bills to be discounted in the open market. In such cases, 
the correspondent retains the documents (which give possession to 
the goods), and sells the draft as a clean bill. The bill then runs to 
maturity. When the acceptor announces that he is ready to pay the 
draft less the rebate, the banker receives the money, turns the docu- 
ments over to him, and guarantees that the draft will be paid in full 
at maturity. 

Where the credit standing of the drawee is not well known or is not 
considered to be of the very best, or where there is more than ordinary 
risk involved, or where the commodities shipped are perishable, it is 
customary to have the documents go forward under “D. P.” instruc- 
tions. It is not unusual, therefore, for trade acceptances to be “D. P.” 
bills. When the draft is drawn against a bank, however, documentary 
bills are always “D. A.” bills, because there is no question involved 
as to the credit standing of the bank. If definite instructions do not 
accompany the bills, documents are delivered only against payment 
in India and other eastern countries and occasionally in Europe, but 
in some oi the South American countries they are turned over to the 
drawee only upon acceptance. The laws of some of the South Amer- 
ican countries accord the merchants the right to demand and to obtain 
the documents when they accept, regardless of the instructions that 
may accompany the bill of exchange. The following letter addressed 
to a bank in the United States by a bank of Lima, Peru, depicts the 


146 DOMESTIC AND FOREIGN EXCHANGE 


attitude of the merchants and banks of that country toward “D. P.” 
bills: 


“Dear Sirs: 

We beg to confirm our cable of the 5th instant reading as 
follows: 

‘REFERRING YOUR LETTER 7TH & 8TH ULTIMO YOUR RE- 

MITTANCES 48 TO 53 AND 59 TO 60 DRAWEES DEMAND DE- 

LIVERY DOCUMENTS AGAINST ACCEPTANCE—TELEGRAPH 

INSTRUCTIONS’ 
which refers to ‘your collections” .../......5 4, -.:. so) en ee 
all drawn at sixty days’ sight. 

“Regarding the above transactions, we beg to call your attention to 
the fact that such drafts, in the form they are issued, i. e., at sixty days’ 
sight, with instructions to deliver documents against PAYMENT and not 
against ACCEPTANCE cause us a great deal of trouble. The merchants 
of this country are accustomed since early years, to have surrendered to 
them, corresponding documents against ACCEPTANCE OF TIME 
DRAFTS; which means to them to enjoy the privilege of credit for the time 
at which items are drawn. Furthermore, the Law of this country upholds 
the merchants in their contentions. 

“Time Drafts should come with instructions of delivering documents 
against ACCEPTANCE and in case of cash payment being desired (that 
is, documents against PAYMENT) SIGHT BILLS should be drawn. 

“We shall be obliged if in future you will bear the foregoing in mind and 
refrain from forwarding us for collection, TIME DRAFTS with documents 
to be surrendered only against PAYMENT. 

“We trust the above is quite explanatory and shall appreciate your 
usual good attention to the matter which has compelled us to write this 
letter. 

“Yours faithfully,” } 


1 The following letter from a bank in Bolivia to a bank in the United States is likewise 
of interest in the above connection: 


“Gentlemen: 
Collection” iin aec's ss cae ot Sh oie ee Mine kaos ola dele a sia aly 00) gta nn 
““We beg to call your attention to the discrepancy which we note in your instructions 
given us in reference to the above collection. The draft is drawn at 120 days’ sight and 
you tell us that the documents should be handed against payment. We do not know this 
way of proceeding and rather believe that this is an error or a ridiculous inconsistency. 
It is plain to us in this country, that if a drawing is issued at 120 days’ sight, with docu- 
ments, said documents should be deliverable against acceptance of draft and not against 
payment. If it had been the wish of the Drawers to give instructions to hand the docu- 
ments against payment, why the draft should simply have been drawn at sight. We fail 
to understand in this country what benefit a person would enjoy by having drafts drawn 
on him at 120 days’ sight, as in this case, when he is unable to procure corresponding docu- 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 147 


The instructions that accompany a documentary bill of exchange 
may contain the designation “D. D.,’’ which means simply that the 
documents are to be delivered to the party concerned. Such instruc- 
tions are employed only when goods have been shipped with the 
understanding that the documents are to be forwarded immediately 
and that payment may be made at some later date by means of a 
draft upon the importer or by the latter forwarding a remittance 
to the shipper. In this case the documents are turned over to the 
bank as the shipper’s forwarding agent. 

There often appears on the face of the draft, or more frequently 
on the instruction blank accompanying the bill of exchange, the 
Sree Case OLsaneed, with. -oiiiy elu er cine ne 7 or **In} case 
ER CAD MUO 30 Liv. 5% ore pom cttioee , the name and address 
of some business concern, bank, shipping agency, branch office of 
the exporter, or individual being inserted. This party, known as a 
“referee in case of need,” is usually located in the country upon which 
the draft has been drawn and may be called upon by the holder of the 
bill to straighten out any difficulty that may arise between him and 
the importer and thus save the expense of delay, cablegrams, protest 
fees, etc., which would otherwise result. It frequently happens that 
the importer’s “refusal to accept or pay a draft arises from some 
trivial matter which can be adjusted easily by a tactful intermediary, 
but which otherwise would involve expensive cablegrams and negotia- 
tions at long range. If the ‘case of need’ succeeds in adjusting the 
point in dispute so that the drawee becomes willing to complete the 
transaction, then the matter is closed without material expense to the 
exporter. Or, failing to arrive at any agreement, the local representa- 
tive (‘case of need’) may honor the draft himself or make some arrange- 
ment with another importer to take over the goods upon satisfactory 
terms. On the other hand, it may be that the ‘case of need’ finds it 
_ hecessary to make certain concessions to the buyer. The local bank 
holding the draft then is in the position to cable a concrete proposal 
on behalf of the purchaser to the American bank which originally 


ments without payment. In what manner is he to procure the necessary funds if he cannot 
take possession and dispose of the relative merchandise and receive the proceeds therefrom? 
“‘With this explanation, we beg to inform you that in future we shall not take upon 
ourselves any collections that contain such contradictory instructions, and we must again 
inform you that such proceedings are not known here as they are very evidently absurd. 
“Expecting that you will find our remarks in order, we remain, 
“Yours very truly,” 


148 DOMESTIC AND FOREIGN EXCHANGE 


started the bill along for collection. If it is desired that the powers 
and authority of the ‘case of need’ exceed those described above, then 
the necessary authorization or power of attorney should be filed both 
with the ‘case of need’ and with the bank which negotiates the draft 
in the United States.” ! 

Other terms that appear on the drafts themselves or in the instruc- 
tions which accompany the documents, such as the “colonial clause,” 
the “interest clause,” the phrase “exchange as per indorsement,” 
etc., will be explained in later chapters. 

Documentary bills, unlike clean bills, are comparatively safe for 
the exchange dealer to purchase, because, aside from the liability of 
the drawer, which, as has been seen, does not cease until payment of 
draft, the documents normally afford practically complete protection 
against loss. When prices are falling rapidly, as they did during 1920- 
1921, bankers and others run great risks through the refusal of the 
drawee to accept the drafts covering goods contracted for at higher 
prices, and also through the failure or bankruptcy of the exporting 
firms from which the bills have been purchased. In normal times, 
however, documentary bills covering shipments of staple non-perish- 
able products, such as flour, farming implements, canned meats (or 
fresh meats and provisions when shipped in refrigerator cars and 
vessels), etc., are comparatively safe because the goods can usually 
be sold in the market where consigned, if a forced sale is necessary, 
at prices that will reimburse the bank for its outlay. Ifa small bal- 
ance remains unpaid, it can usually be collected from the indorsers 
or drawer without difficulty, while if a surplus be realized it is re- 
turned to the drawer. Cotton bills should be purchased only from 
well-known and responsible shippers because there are so many grades 
with a different price for each and because it is so easy to substitute 
one grade for another. Bills against grain shipments are usually safe 
provided the grain inspector at the shipping point is of good repute 
and will not certify a higher grade for a lower. Bills covering ship- 
ments of perishable fruits, goods, etc., because of the chance of spoilage, 
naturally involve more or less risk, as do those covering live stock, 
because any delay at destination necessitates the expense of feed and 
attention, or those covering specialties, such as pianos, phonographs, 
musical instruments, etc., because they can rarely be sold at auction 
at anywhere near the price at which they have been billed. 


1 Foreign Trade Bulletin of the American Express Company, May-June, ta78, 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 149 


Documentary bills, regardless of the conditions existing, should 
be dealt in only by those who are thoroughly trained in that phase 
of foreign exchange, because it means, when the transaction is stripped 
of all its outward characteristics, the loaning of money upon goods 
that the exchange dealer has not seen. ‘The attachment of docu- 
ments does not enhance the value of the draft in every case. The 
standing of the drawer is what counts in first Instance, as documentary 
bills are not easily negotiable in the open market and they protect 
only while documents are attached. The acceptance of the drawee 
adds usually to the value of the paper, especially when the acceptor is 
a bank, a banker, or merchant of good standing and reputation.” ! 
If the drawer and the drawee have excellent financial standing, that 
of course eliminates the principal source of loss. But even then, great 
care should be exercised by the dealer in purchasing bills so that no 
vossible difficulty may arise to impair their value. The bank clerk 
should note whether all documents are drawn in accordance with the 
terms called for in the letter of credit. He should examine the bill 
of lading to see that it is correctly dated and corresponds with the 
shipment made; that it declares that the goods were received in good 
condition; that it is duly signed by the agent or the proper official of the 
railway or steamship company; that it corresponds with the insurance 
certificate or policy in all particulars; that all negotiable copies of the 
bill of lading are in his possession; and that there are no stamped or 
printed conditions on it that might render it valueless in case of an 
emergency. He should know the market value of the goods shipped, 
so as to be sure that the draft is not drawn for a larger sum than could 
normally be realized should the goods have to be sold by the bank 
in order to collect its claim. Information concerning the value of 
commodities can be obtained from the various trade journals or from 
local firms dealing therein. The banker should keep continually 
posted as to the financial standing of the drawer, and if possible of the 
drawee. If the goods are perishable, he should take care to see that 
they are to be sent by fast freight or steamer or in refrigerator cars 
and vessels. If sent from some small inland point where it is not 
possible to obtain a through bill of lading to the point of destination, 
he should make the necessary arrangements with a broker or the bank’s 
correspondent at the seaport to have the original bill of lading ex- 


1Gonzales, V., “‘Modern Foreign Exchange,” N. Y., 1920, second edition, pp. 
41-42. 


150 DOMESTIC AND FOREIGN EXCHANGE 


changed for a through bill of lading.'’ In every seaport there are a 
number of firms that make a business of acting as forwarding agents 
for inland customers, exchanging bills of lading, arranging for ship- 
ment of goods on the proper lines, etc. He should also note whether 
or not the insurance in effect on the shipment is for the proper sum, 
whether or not it covers the goods from the time they leave the ex- 
porter’s hands until they reach the importer, just what length of time 
and what route the policy covers, and whether there are any clauses 
in the insurance policy or certificate or attached thereto by stickers 
that may make it either difficult or impossible for the bank to collect a 
claim for damages. And in the case of all documents needing indorse- 
ments, he should note that the indorsements are in proper form, in 
order that the documents may be easily negotiated and the bank’s in- 
terests completely protected. Any error or incompleteness may cause 
delay and necessitate loss of interest, protest fees, cablegram costs, etc. 

Practically all of the important banks (both domestic and foreign) 
in the United States that are engaged in buying documentary bills 
of exchange have adopted a uniform set of rules governing payments 
of commercial credits and the handling or purchasing of documents 
drawn thereunder, and have notified their correspondents to the fol- 
lowing effect: 


TO CORRESPONDENTS: 

Payments under Export Commercial Credits advised to the undersigned 
are made in conformity with the following regulations, which are in accord 
with the standard practice adopted by the New York Bankers Commercial 
Credit Conference of 1920: 

1. We assume no liability or responsibility for the form, sufficiency, 
correctness, genuineness or legal effect of any documents, or for the de- 
scription, quantity, quality, condition, delivery or value of the merchandise 
represented thereby, or for the good faith or acts of the shipper or any 
other person whomsoever; but documents will be examined with care 
sufficient to ascertain whether on their face they appear to be regular in 
general form. 

2. We will interpret the terms “documents,” “‘shipping documents” and 
words of similar import, as comprehending only ocean bills of lading (sailor 
bill of lading included) and marine and war risk insurance, in negotiable 
form, with invoices. 

3. Unless specifically otherwise instructed, we will accept “received for 
transportation”’ bills of lading in the form customarily issued in New York. 

1 Brooks, op. cit., p. 189. 


” 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE  I51 


(The steamship lines constituting the Transatlantic Conference state that 
the customary procedure necessitated by American port conditions, is to 
issue bills of lading against the receipt of goods into the custody of the 
steamship owners or agents, for transportation by a named steamer, and 
failing shipment by said steamer, with liberty to ship in and upon a prior 
or following steamer. They state that it is not possible here to issue ‘‘on 
board” bills of lading, but have agreed, after the goods are loaded, so far 
as reasonably practicable, to indorse on the bills of lading, if returned for 
the purpose by the shippers, a dated clause to the effect that the within 
goods have been loaded on board, specifying any portion that has been 
“short shipped.” They represent, however, that such procedure will not 
be reasonably practicable in all trades, nor in any trade at all times, and 
where used, on account of the delay involved, may result in the merchandise 
arriving at destination in advance of the bills of lading.) When specifically 
requested by a correspondent, we will request the “on board” indorse- 
ment, and obtain it, where practicable. 

4. When the ‘‘on board”’ indorsement is not specifically requested by a 
correspondent, or it is impracticable to obtain it, the date of the bill of 
lading will be taken to be the date upon which shipment has been effected. 
When the “on board”’ indorsement is obtained, the date of such indorse- 
ment will be taken to be the date upon which shipment has been 
effected. 

5. Instructions shall be interpreted according to our law and customs, 
but in any event, in accordance with the following general rules: 

A. Forwarders’ bills of lading will not be accepted, unless specially 
authorized. Railroad through bills of lading will not be accepted, 
except on exportations to the Far East via Pacific ports, unless ex- 
pressly stipulated. 

B. Bills of lading shall contain no words qualifying the acceptance 
of the merchandise in apparent good order and condition. If “on 
board”’ bills of lading are stipulated, they shall acknowledge receipt 
of the goods on board a named vessel. Otherwise, “received for trans- 
portation”’ bills of lading, which acknowledge the receipt of the goods 
into the custody of the steamship owners or agents for transportation 
by a named steamer, and failing shipment by said steamer with liberty 
to ship in and upon a prior or following steamer, will be accepted; 
and insurance certificates, if required, shall cover shipment corre- 
spondingly. 

C. Documents for partial shipments will be accepted, even if the 
pro rata value cannot be verified, unless expressly prohibited. 

D. The use of “to,” “until ” “on,” and words of similar import, 
in indicating expiration, is interpreted to include the date mentioned. 


152 DOMESTIC AND FOREIGN EXCHANGE 


E. When the indicated expiration date for payment falls upon a 
Sunday or legal holiday here, the expiration is extended to the next 
succeeding business day. 

F. The terms “‘prompt shipment,” “immediate shipment,” ‘ship- 
ment as soon as possible” and words of similar import, shall be inter- 
preted as requiring shipment to be effected and (if the credit advice 
is without expressed duration) the stipulated documents presented 
for payment within thirty days from the date of our credit ad- 
vice. 

G. Our credit advice if without expressed duration, shall not con- 
tinue in force longer than one year from its date. 

H. The stipulated documents must all be presented not later than 
3 p. m. (or twelve o’clock, noon, if Saturday) on the indicated expira- 
tion date. 

I. The terms ‘‘approximately, about,”’ or words of similar im- 
port, shall be construed to permit a variation of not to exceed ten 
per centum. 

J. Definitions of Export Quotations will be those adopted by the 
National Foreign Trade Council, Chamber of Commerce of the U. S. A,. 
National Association of Manufacturers, American Manufacturers’ Ex- 
port Association, Philadelphia Commercial Museum, American Ex- 
porters’ and Importers’ Association, Chamber of Commerce of the 
State of New York, N. Y., Produce Exchange, and New York Mer- 
chants’ Association, at a conference held in India House, N. Y., on 
December 16, 1919. 

6. Correspondents will understand that the above regulations shall govern 
in all credit transactions in the absence of other specific agreements. If 
the beneficiary shall make representations, or shall offer security, satis- 
factory to the bank, that no loss shall result to its correspondent or client 
by the waiver of any of such regulations or any instruction, the bank re- 
serves the right to make such waiver, and shall recognize no claim in the 
premises unless substantial direct damage shall be shown to have 
resulted. 


+d 66 


In order to protect themselves against possible losses resulting from 
their transactions in documentary bills of exchange, bankers take 
from exporters, whose bills they purchase, a document known as an 
“hypothecation certificate.” In case a large number of bills are to 
be purchased, a “general letter of hypothecation” (Fig. 35) is taken 
and retained by the bank, but if only one or a few bills are involved 
then a separate certificate of hypothecation is taken and attached 
to the draft along with the other documents. 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 153 


GENERAL LETTER OF HYPOTHECATION 


To the Tenth National Bank, New York. 

Gentlemen :-— 

Having in contemplation transactions with you from time 
to time in the sale of Bills of Exchange with Shipping Documents for goods 
or produce attached as collateral security, which documents are to be held 
by you for the due payment of the same, we hereby declare that upon the 
sale by us to you of any such Bills of Exchange our agreement with you 
is understood to be as follows: 

You may insure any goods forming the collateral security (if not already 
insured, and the policy or policies deposited in your hands), from sea risk, 
including loss by capture, and from fire on shore, and add the premiums 
and expense thereof to the amount chargeable in respect of the said Bills, 
but it shall not be imperative upon you to effect any such insurance. 

You may sell any portion of the said goods which you may deem neces- 
sary for payment of such premiums and expenses, freight, or duties, and 
take such measures generally, and make such charges for commission, and 
are to be accountable in such manner, but not further or otherwise as in 
ordinary cases between a Merchant and his Correspondent. 

You may take conditional acceptance to such Bills to the effect that on 
payment thereof at maturity or under discount the documents handed to 
you as collateral security shall be delivered to the Acceptors, and this 
shall extend to acceptances for honor. 

In case default be made in acceptance of the said Bills on presentation, 
we agree immediately on receiving notice from you that you have been 
advised by telegraph of such non-acceptance, and without waiting for or 
requiring the protest of the said Bills, that we will pay to you the amount 
thereof, with all charges of every description incurred by you in conse- 
quence of the non-acceptance of the said Bills, or give you a margin which 
shall be satisfactory to you, either in cash or Securities, and notwithstanding 
that the goods or produce against which the said Bill is drawn, or the Docu- 
ments thereof remain in your possession in the United Kingdom or else- 
where; and we hereby agree that your account of the disbursements, com- 
mission and charges, incurred by you in consequence of the non-acceptance 
of the said Bills shall be received by us as sufficient evidence of the amount 
of such disbursements, commission and charges, and shall not be open to 
objection of any kind. 

In case default be made in acceptance or payment of any of the said 
Bills, or if the Drawees or Acceptors should suspend payment, or be ad- 
judicated Bankrupt, or execute any Deed of Arrangement, Composition, 
or Inspectorship or take any other steps whatsoever towards effecting a 
compromise or arrangements with their creditors during the currency of 


154 DOMESTIC AND FOREIGN EXCHANGE 


the said bills, you may at any time after either of the aforesaid events 
taking place, sell the goods or any part thereof without notice to or the 
concurrence of any person whomsoever without waiting for the maturity 
of the said bills, and either by public auction or private sale, and you may 
act in all respects as if you had been the direct consignee of the goods, 
charging such commission as is usual between a Merchant and his Corre- 
spondent in ordinary cases, and shall apply the net proceeds of any sale, 
after deducting any payment made under the powers herein contained, 
with interest thereon and the usual commission and charges, in payment 
of the Bills with interest, re-exchange and other charges, and may retain 
the balance (if any) towards liquidation of any debt or liability of ours to 
you whether or not the same be then payable or ascertained, it being hereby 
agreed that the goods themselves until sale shall be liable for and be charged 
with the payment of all such Bills, with commission, interest, re-exchange, 
and other charges, debts, or liabilities, and we agree that all account sales 
and accounts current furnished by you in respect of the said goods shall 
be received by us as sufficient evidence of the accuracy of the transactions 
to which they refer, and shall not be open to objection of any kind. 

We further authorize you, in case the net proceeds of the sale of such 
goods shall be insufficient to pay the amount of the said Bills, with disburse- 
ments, interest, re-exchange and charges, to draw upon us at the exchange of 
the day for the amount of such deficiency, and we engage tohonor such drafts 
on presentation, or even without such drafts being sent, to pay you the 
amount of such deficiency on your informing us of the amount. 

In case the aforesaid Power of Sale shall not have arisen during the 
currency of the said Bills, you may accept payment from the Drawees or 
Acceptors thereof, and on payment deliver the said Bills of Lading and 
Shipping Documents to such Drawees or Acceptors. 

In case the Drawees or Acceptors should wish to take delivery of any 
portion of the Goods held as collateral Security against the said Bills before 
maturity thereof, you are authorized (but not so as to be binding on you) to 
make such partial deliveries on receiving payment of a proportionate part 
of the said Bills. 

The delivery to you as aforesaid of the above mentioned collateral secu- 
rities is not to prejudice any of your rights on the said Bills in case of dis- 
honor, nor shall any proceedings taken thereon prejudicially affect your 
title to the said securities. 

All rights, powers, and authorities hereinbefore given to you shall ex- 
tend to and may be exercised by the holders for the time being of the said 
Bills and Shipping Documents. 

It is understood that in the event of Bills being paid under discount, 
rebate of interest shall be allowed as follows:— 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 155 


At one-half per cent per annum above the advertised rate of interest for 
short deposits allowed by the leading London Joint: Stock Banks, if the 
Bills are taken up in the United Kingdom of Great Britain and Ireland. 

At the current minimum rate of Discount of the National Banks of 
France, Italy, Belgium and Germany respectively if taken up in either of 
those Countries. 


eee em ecee eeeesetreee eee 


FIGURE 35 


The letter or certificate of hypothecation is merely a rather detailed 
statement given by the exporter, i. e., the seller of the bill of exchange, 
to the purchasing bank, containing an enumeration of the powers 
and privileges of the latter as the buyer of the draft. It recites that 
the bank has the right to insure the goods against all risks, if such has 
not already been done; that it may sell all or any part of the goods in 
order to satisfy its claims for expenses, commission, and principal; 
that if sufficient funds are not provided by the sale of the goods, the 
exporter will reimburse the bank for the deficit; and that the bank 
shall have all authority necessary to enable it to handle the trans- 
action in a manner that will protect its interests. In other words, the 
letter or certificate of hypothecation represents a rather complete and 
detailed bill of sale and, while it gives the bank few if any powers 
that it would not otherwise possess before the law, it does neverthe- 
less clearly set forth those powers in the shape of a formal agree- 
ment and thus prevents a controversy arising in the future between 
the bank and the exporter in case there be non-acceptance or non- 
payment of the draft. 

It is not possible or necessary for us to enter into a detailed discussion 
of the various papers that must be prepared and handled by an ex- 
porter in getting his goods ready for shipment. Anyone interested 
in the details of clerical work in connection with foreign shipments, 
such as export licenses, shipping permits, export declarations, dock 
receipts, etc., will find full explanations of those matters in the many 
volumes that deal with the technic of foreign trade.! In this volume 
only those papers concern us that are related to the financing of the 
transaction. 

We have seen that a documentary bill of exchange is usually made 


1Cf. Hough, B. O., ‘‘ Practical Exporting” ; deHaas, A., ‘‘ Foreign Trade and Shipping,” 
etc. 


156 DOMESTIC AND FOREIGN EXCHANGE 


up of the draft, bill of lading, invoice, and insurance certificate or 
policy, although there are other documents that may be required under 
certain conditions and as a consequence of the requirements of the 
laws of trading countries. We have already referred briefly to some 
of the documents that are commonly found in the field of foreign ex- 
change, but it is advisable to describe them in more detail than has 
been done in preceding pages. 













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Draft drawn by exporter on importer 


As has been noted above, the draft is drawn either by a merchant 
(the exporter) against another merchant (the importer) (Fig. 36) 
or by the exporter against a bank or financial agent with which the 
importer has made the necessary arrangements (to be described more 


FUNDAMENTALS OF FOREIGN BILLS.OF EXCHANGE _ 157 


fully in our discussion of commercial letters of credit). It is usually 
drawn in duplicate, although at times in triplicate, occasionally in 
greater number. Each of the copies issued bears its number, i. e., 
“original” or “first of exchange,” “duplicate” or “second of ex- 
change,” “triplicate” or “third of exchange,” etc. Duplicate or 
triplicate drafts are drawn, as is the case with the other documents, 
so that one set of documents may be sent by one steamer, another by 
a second steamer, etc., as a precaution against loss in transit. The 
drawer will also usually keep a complete set of documents for his own 
file ready for future reference. The first complete set of documents 
to arrive, regardless of whether or not they are the originals, dupli- 
cates, or triplicates, are the ones that are used to carry through the 
transaction. The others become void and are filed away by the 
correspondent bank or importer. The usance of the draft is custom- 
arily thirty to ninety days, although short time bills, and bills for a 
longer term than ninety days, are not unusual. The usance depends 
upon the agreement between the seller and the buyer, but the really 
determining factor is the custom of the trade and of the country to 
which the goods are shipped.” The credit standing of the importer, 


1 Cf. Chapter IX. 
2A concise and excellent statement of the credit terms in Latin American trade, pre- 
pared by the Guaranty Trust Company of New York, is in part as follows: 


Custom of many years’ standing has made the go days sight draft the most generally 
used instrument of credit in South America. Probably eighty to ninety per cent of the 
foreign business is done on those terms. The banks even carry their sterling accounts in 
go day bills, checks on which read payable in exchange on London at go days after sight. 

Another good reason for asking terms other than cash in advance or on arrival of goods 
is the natural desire of the merchant to get his purchases in his warehouse and examine 
and list them. Usually, too, it takes quite some time to put them through the customs. 
Then again the importer may be an agent and the goods may have to go back into the 
country where transportation is difficult, in which case he himself will have to wait perhaps 
six months before receiving his final payment. 

It is not, therefore, a desire to be financed by the foreign seller that prompts this request 
for credit as much as the necessity arising from the circumstances of the trade. 


The following are the usual terms required: 


Argentina: The big houses in Buenos Aires do a large amount of business for cash against 
delivery of documents, but bills at 60 and 90 days are common. In Rosario and other 
outlying districts 90 days after receipt of goods is quite generally the custom, and even 120 
days in Mendoza and up-country. For textiles 120 days is the usual time allowed for pay- 
ment and for machinery 150 days may be demanded. Although interest at six per cent is 
added, it should be included in the face of the draft as only the amount of the face of the 
draft is legally collectible in Argentina. 


Bolivia: Terms are not less than go days after sight and range up to 150 days, dry goods 
requiring 120 days. The rule is to accept drafts only on arrival of goods at customhouse. 
Documents are very seldom held for payment, being delivered almost in every instance 


158 DOMESTIC AND FOREIGN EXCHANGE 


the length of time that he has been established, the extent of his bus- 
iness, are factors that also enter into the length of time for which 


upon acceptance. Transportation is particularly slow and arduous, pack animals being 
required very extensively. 


Brazil: The best houses secure credits at 90 days sight. In the out ports 120 days is 
quite common, especially for textiles, while heavy machinery frequently requires six to 
nine months. 


Chile: While some business is done on open credit, 90 days after sight is almost universally 
the custom at Valparaiso, the principal port, while at Iquique it is 90 to 120 days. 


Colombia: Buyers require usually from 30 to 60 days after goods pass through the custom 
house, but six to nine months’ bills are quite common. Discount cost plus interest at six 
per cent is generally added. Discount for cash or prepayment is usually at the rate of five 
per cent per annum. The custom among wholesalers in Colombia is to allow retailers and 
agriculturists six months’ credit. 


Costa Rica: Although many will pay cash for a liberal discount, 90 to 180 days is cus- 
tomary. 


Cuba: Credit terms are for three, six and twelve months, according to the commodity, 
with six per cent interest added. Discounts offered are usually five or six per cent. 


Dominican Republic: Generally four to six months credit is granted, plus interest at 
six per cent. 


Ecuador: The rule is 30, 60 and go days sight bills, but the up-country trade requires 
seldom less than go days and usually six months to a year, plus six per cent interest. 


Guatemala: Ninety days to six months are granted, usually the former, but not infre- 
quently six months after arrival of goods is required, with interest at six per cent. 


Haiti: General rule is six months from date of invoice, but quite frequently the time 
runs from receipt of goods in warehouse, with interest at six per cent. 


Honduras: Many leading firms take advantage of discounts for cash, but six months’ 
credit is usual. At Puerto Cortez the prevailing terms are 30, 60 or go days, plus six per 
cent interest or five per cent discount. 


Nicaragua: Usual terms six or nine months’ bills. 
Panama: Usual terms six months. 


Paraguay: The general rule is six months after clearance through customhouse, but 
as officials allow quite long warehousing in bond agreement should be made limiting time 
for clearance. 


Peru: Usual terms go days sight, but 60 days, 120, and even 180 days are quite common. 
Interest is usually at six per cent, and eight per cent for extension. Dry goods require 120 
days, and machinery, especially sugar machinery, is sold on long credit, sometimes as 
much as three years, with a payment of one third in cash on receipt of invoice. 


Salvador: Bills at six to nine months, with interest at five to eight per cent, though a 
liberal discount for cash is usually taken advantage of by the importing houses. 


Uruguay: Open accounts are quite generally allowed to well-established Montevideo 
houses. Otherwise 30 to 60 days sight bills are the rule. Up-country trade requires six 
months’ credit. 


Venezuela: Large amount of business is done on open account but usually payment is 
by bills of three to six months’ time. Discounts for prepayment are availed of by manv 
firms. As the consignees named in the consular invoice can always obtain goods from the 
customhouse without having any papers in his possession, the bills of lading having no 
standing in Venezuela as commercial documents, the attaching of such documents to drafts 
affords no security. If acceptance or payment should be required before delivery of goods 
to purchaser the only way is to invoice the goods to the banking house that is to make the 
collection. 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE = 159 


credit is given and assist in determining the usuance of the draft. The 
shipper usually indorses the draft in blank when he hands the docu- 


ments to the bank. 
The bill of lading (B/L) is without doubt the most valuable and 
important of all the documents that accompany the draft (Fig. 37), 


= 







Received is apparent coed canter and condition by AGENTS OF RED “D” LINE OF S. 8. 
tom Henry Smith_and Co.- of San Frane Isc oO, % to be transported by the- steamship 
“Ocean Ware” now lying in tho port of PAN Trancisco.. 


with liberty to call at any port or ports in the Schedule, without regard to the order ied; and to call at that or other ports in the Schedule 
to land passengers and mails, and afterwards return to land cargo; or failing shipment by said stcamer, in and upon a following steamer. 

























being marked and numbered, as per margin, shipper’s weight (quality, quantity, “gauge, contents, weight and value unknown), and to be delivered 


in like good order and condition, at the port of__~pp.1V 2. a bez . 
o—_hiver bool, or to his or their assigns, he or 








unto. Jr aer: _ nots fs WA Pa S$.9rn 


they paying freight, primage and charges immediately on discharge of the goods, without any allowarce of credit or discount, on tho gross intaken 
weight or measurement as per margin, or as may otherwise result on verification of same at port of destination. 

IT IS MUTUALLY AGREED that the steamer shall have liberty to sail with or without pilots; that the carrier shall have liberty to convey 
goods in craft and/or lighters to and from the steamer at the risk of the owners of the goods; and, in case the steamer shall put into a port of 
refuge, or be prevented from any causo from proceeding in the ordinary course of her voyage, to transship the goods to their destination by any 
other steamer; that the carrier shall not be liable for loss or damage occasioned by perils of the sea or other waters, by fire from any cause or 
wheresoever occurring; by barratry of the master or crew; by enemies, pirates or robbers; by arrest or restraint of princes, rulers or people, riots, 
strikes or stoppage of labor; by explosion, bursting of boilers, breakage of sbafts, or any latent defect in hull, machinery or appurtenances, or 
unseaworthiness of the steamer, whether existing at time of shipment, or at the beginning of the voyage, provided the owners have oxercised due 
diligence to make the steamer seaworthy; by heating, frost, decay, putrefaction, rust, sweat, change of character, drainage, leakage, breakago, 
vermin, or by explosion of any of the goods, whether shipped with or without disclosure of their nature, or any loss or damage arising from the 
nature of the goods or the insufficiency of packages; nor for inland damage; nor for the obliteration, errors, insufficiency or absence of, marks, 
numbers, address or description; nor for risk of craft, hulk or transshipment; nor for any loss or damage caused by the prolongation of the voyage, 
and that the carrier shall not be concluded as to correctness of statements herein of quality, quantity, gauge, contents, weight and value. General 
average payable according to York-Antwerp Rules. If the owner of the steamer shall have exercised due diligence to make ezid steamer in all 
respects seaworthy and properly manned, equipped and supplied, it is hereby agreed that in case of danger, damage or disaster resulting from fault 
or negligence of tho pilot, master or crew in the pavigation or management of the steamer, or from latent or other defects, or unseaworthiness of 
the steamer, whether existing at time of shipment, or at the beginning of the voyage, but not discoverable by due diligence, the consignees or owners 
of the cargo shall not be exempted from liability for contribution in General Average, or for any special charges incurred, but, with the ship- 
owner, shall contribute in General Average, and shall pay such special charges, as if such danger, damage or disaster had not resulted from such 
fault, negligence, latent or other defects or unseaworthiness. 

IT 18 ALSO MUTUALLY AGBEED that this shipment is subject to all the terms and provisions of, and all the exemptions from liability contained in, the }' 
Act of Congress of the United States, approved on the 13th day of February, 1893, and entitled, ‘‘An Act relating to the navigation of vesseils, etc.’” 

1.—IT IS ALSO MUTUALLY AGREED that the value cf each package receipted and charges no incurred. 


deliver AT TIME OF SHIPMENT a notice tn writing expressing the nature 
SAND DOLLARS. 








MATCHES, GUNPOWDER or other goods of explosive, burning or of otherwise dangerous character 





ATTENTION OP GHIPPERS 18 CALLED TO THE LAWS OF THE ONITED STATES which provide that any persos 








o 
° 
zm 
i 
o 
Zz 
° 
2 
a for as above docs not exceed the sum of One Hundred Dollars unless otherwise 7T.—ALSO, that if on a slo of the goods at destination for freight and charges, §. 
@tated herein, on which basis tho rate of freight ia adjusted, tho proceeds fail to cover ssid freight and charges, the carrier shall be entitled to 
2.—ALSO, that the carrier shall not be liable for articles specified. in Section recover the difference from the shipper. 4 
4281 of the Revised Statutes of the United States, unless written notice of the 8.—ALSO, that full freight is payable on damaged or unsoynd goods; dot no 
8 fi Cae ad and value thereof is given at the time of lading and entered in the dla < due on any increase in bulk or weight caused by the absorption of water 
of lading. ’ uring the voyage. 

as 8.—ALSO, that shippers shall be liable for any losa or damago to stcamer or - J—ALSO, what in the event of claims for short delivery when tho stesmor 

aS enrgo, caused by inflammable, explosive or dangerous goods, shipped without full reaches ber destination, the price shall be the cout price at port of shipment on the 

ss disclosure of their nature, whether such shipper be principal or agent; end such day the steamer sailed plus freight and insurance. é i 

goods may be thrown overboard or destroyed at any time without compensation. 10.—ALSO, that merchandise on wharf ewaiting shipment or delivery be at 
2 4.—ALSO, that the carrier shall have @ liea on the goods for all freights, shipper's risk of loss or damage not Bappaeae through tho fault or negligence of 
prime, and charges, and also for all fines or damages which tho steamer or cargo the owner, master, agent or manager of tho steamer, any custom of the port to the 

ey par incur VF suffer by reason of phases inaeerent or insufficient marking, num- contrary Meson gc * ¢ Nees A bet tenes 
ring or addressing of packages or description of their contents, 11.—ALSO, that in the event of any part of the goods not being foun oF 
fs. £ ALSO, that in case the steamer ohal! be prevented from reaching her desti- delivery during the Stoamer’s stay, at port of destinntion ssid goode may bo for 

a gs mation by Quarantine, the carrier may discharge the goods into any depot or warded or replaced at Ship's expecee but ownor's risk. It being agreed that the |. 

' Vataretto, and such discharge shall be deemed a final delivery under this contract, Steamer shall not be liable for any claim for such deteation or otherwise. 

3 and all tho expenses thereby incurred on the goods shall be s lien thereon 12.—ALSO, that, ia the erent of a blockade or any other cause preventing the 
| 6.—ALSO, that the Steamer may commence discharging Immediately on arrival Janding of the goode at the port of destination the master shall have the option of 
3 2 and discharge continuously, Day, Night, Sundsys and Holidays, any custome of the landing them at any other near port or of bening: them back to port of shipment 
aq 53 |e to the contrary notwithstanding, the Collector of the port being hereby author- as he muy consider advisable, and in event of thoir being brought back to port of 
Su zed to grant @ general order for discharge immediately on arrival, and if the goods shipment the freight for the round voyage shall be double the amount agreed upon 
Bas be not taken from the steamer by tho consignee directly they come to hand in for outward voyage. 
ua discharging tho steamer, the master or steamer’s agent to bo at liberty to enter and 13.—ALSO, that prepaid freight sball not be returned, ebip lost or not lost. 

5 Isnd the goods, or tee them into craft or store at the owner's risk and expense, 14—ALSO; that goods transehipped under this Bill of Lading, aro subject to afl 
= hee the rocks = be peat “aia and egal responsibility pea bot he conditrons ee exceptions noted above and are at owner's risk whilo on dock, 
+ jo steamer and carrier to have lien on such goods until the payment of ail costs no store, sod on lighters. 
i AND FINALLY, in accepting this Bill of Lading, the Shipper, Owner and Consignee of the goods and the Holder of the Bill of Lading agree 
in accepting B, the Shipp : ign goods a ; 
323 to be poe by all cae stipulations, exceptions and conditions, whether written or printed, as fully as if they were all signed by such Shipper, 
Owner, Consignes or Holder. . 


In Witness Wnereor, the Master or Agent of the said steamship hath affirmed es ae of Lading, all of this tonor and date, one of 


which being accomplished, the others to stand void. | -¢ 
pedis Sn trancsisco_this _ 15 *, en nO w® 
a a i FE es ee ee Or det 





FIGURE 37 


Steamship bill of lading 


because it alone gives possession of the goods either to the holder or 

to the consignee, depending upon whether it is an “order” or a 

“straight” bill of lading.’ If the goods have been shipped through 

to their destination from some interior point, a comparatively large 

number of copies must be obtained from the railroad, varying from 
PCA p. 65: 


160 DOMESTIC AND FOREIGN EXCHANGE 


three to eleven, and depending upon the needs of the railroad, the 
exporter, his banker, and the steamship company. If the goods have 
been shipped from some seaport, the number of copies will be less and 
will be obtained from the steamship company. Only those that are 
signed by the proper official of the carrier, usually two or three in 
number, are “negotiable,” and all the negotiable copies must be turned 
over to the shipper. The number of negotiable copies is entered on 
the bill itself with the statement that ‘one of which Bills of Lading 
being accomplished, the others to stand void.” The “non-negotiable” 
copies are for purpose of record only. The exporter may keep one 
of the latter for his office records, may send one to the importer, 
together with a copy of the invoice as an “advice” that the goods 
have been shipped. One copy goes to the captain of the ship. Some 
countries require that the negotiable bills of lading covering goods 
that are being imported must be certified by the consul of that country 
at the point of export. This is especially true of South American 
countries.'_ The consul of some countries requires a non-negotiable 
copy for his files. 

Bills of lading are usually drawn “to the order” of the exporter and 
when indorsed by him, simply by his writing his name across the bill, 
become negotiable. Some countries, however, forbid the use of 
the “order” bill of lading (Venezuela, Costa Rica, Columbia, and 
Panama, for example).* In those cases a “straight” bill of lading is 
necessary and very frequently is made out to a party other than the 
importer but located in the importer’s country, such as the corre- 
spondent of the bank negotiating the draft. Order bills of lading 
customarily bear the clause “to be delivered unto Order: notify 
> (mentioning the name of the consignee). This practice is 
followed so that the correspondent bank, when it receives the docu- 
ments, may know to whom the goods are being shipped and thus 
be able to advise the importer of their arrival. Bills with the “not- 
ify” clause do not give the party mentioned any control over the 
goods until they have presented the properly indorsed bill of lad- 
ing.® 








1 Uruguay, Bolivia, Chile, Costa Rica, Cuba, Peru, Honduras, and San Salvador require 
that all negotiable bills of lading shall be certified by the consul, while Paraguay requires 
only one to be certified, Haiti five, and Panama four. Cf. deHaas, op. cit., p. 101. 

2 During the World War the Allies forbade the use of the ‘“‘order”’ bills of lading to some 
ports because they wished to know to whom the goods were actually being consigned. 

3In 1921 a Brazilian court held that a dual control was created by a bill of iading con- 
taining the “notify” clause. It should not appear, therefore, on bills of lading covering 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 161 


The purchasing bank should make certain that the bill of lading is 
“clean,” i. e., that there is no notation on the bill to the effect that 
the goods have been received by the carrier in damaged condition. 
In the latter case the carrying company issues what is called a “foul” 
bill of lading, which, of course, from the standpoint of the bank, is not 
a satisfactory sort of security for its investment. 

Insurance on land shipments is practically unknown because of the 
liabilities imposed by state and federal laws upon common carriers, 
but on sea shipments it is universal, not only because of the limited 
liability of the steamship company, but also because the possibilities 
of loss are so much greater. Some of the more important contingencies 
are: 


“‘(a) Loss of vessel or cargo or damage sustained from stranding, sinking, 
fire or collision, including salvage and other charges. 

“(b) Loss or damage by sea water or from risks on shore while in transit, 
or awaiting shipment, transshipment or delivery, including those of loading 
and discharge. 

“(c) Loss or damage from theft or pilferage, leakage and breakage, fresh 
water, sweat, etc. 

“(d) War risks, including danger from mines as a result of war-time op- 
erations, riots and civil commotion.” 4 


The liability of the marine carrier is limited practically to its exer- 
cising due diligence in seeing that the ship is seaworthy, “free from 
all defects, latent or otherwise,” * and properly manned, equipped, 
and supplied. If such is the case, neither the shipowner “nor the 
charterers shall be held responsible for damage or loss resulting from 
faults or errors in navigation or in the management of the vessel, nor 
shall they be held liable for losses arising from dangers of the sea, acts 
of God, or public enemies, or the inherent defect, quality or vice of 
the thing carried, or from insufficiency of package, or seizure under 
legal process, or from loss resulting from any act or omission of the ship- 
per or owner of the goods, or from saving or attempting to save life 
or property at sea, or from any deviation in rendering such service. 
It is obvious, therefore, that the responsibility for a good many kinds 
of losses which may be incurred can with difficulty be brought home 
shipments to Brazil. Consignments to that country should be made ‘‘to the order” of the 
shipper himself or ‘‘to the order’’ of the bank negotiating the draft. 

1“*Trading with the Far East,” published by the Irving National Bank, N. Y., 2d edition, 


1920, Pp. 124. 
2 Hough, “Practical Exporting, ’’3rd ed., 1919, p. 421. 


162 DOMESTIC AND FOREIGN EXCHANGE 


to the carrier. The shipper’s protection against other losses must be 
secured through marine insurance.” ! 

The marine insurance policy usually covers only the loss or damage 
resulting directly from the “perils of the sea.”’ If a person desires 
to cover loss from other causes, such as deterioration of the goods in 
transit, breakage, pilferage, fire, etc., it is necessary to include clauses 
to that effect and to pay extra premiums therefor. Losses from pilfer- 
age were very great during the World War and have continued down 
to date. It has been estimated by one British shipowner that claims 
for pilferage have increased about 2000 per cent since 1913,” a situation 
that has naturally tended to increase the premiums on insurance 
against theft and robbery. Where ordinarily these premiums have 
been about 5/8 of one per cent on the invoice value of the goods, 
they are now from three to four times that amount. At present 
(April, 1922) British and American steamship companies refuse to 
hold themselves responsible for pilferage where the loss can be covered 
by insurance, and proof of negligence on the part of the carrier is 
necessary to obtain damages. Needless to say such negligence is a 
very difficult matter to prove in court. British and Dutch under- 
writers have also adopted the policy of covering theft risks up to only 
seventy-five per cent of the value of the shipment. The ever present 
danger from floating mines makes it still advisable to carry war risk 
insurance. Newspapers even yet occasionally report ships being blown 
up by floating mines in the North Sea and in the Mediterranean. 

The insurance policy of today contains many clauses and expressions 
which appear old-fashioned and, to the uninitiated, also meaningless. 
Some of the policies issued by American marine insurance companies 
and by the U. S. War Risk Insurance Bureau ? during and after the 
World War have been couched in somewhat more modern terms. The 
reason for the dominance of the British or old-fashioned form of policy 
is that, having been in use for centuries, the English courts have es- 
tablished a body of interpretations and decisions covering the various 
phases of marine insurance, and to change the form of the policy at 
this late date would raise many questions as to the meaning of the 
newer statements and necessitate interpretation by the courts. 

Prior to the World War, English companies controlled more than 


1 Hough, op. cit., p. 436. 

2 Foreign Trade Bulletin of the American Express Company, March, 1921. 

3 The U.S. War Risk Insurance Bureau insured only against marine war risks, the cargo 
having to be insured against other risks in approved companies. 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 163 


two-thirds of the marine insurance business of the United States. 
There were relatively few American companies operating in the field ', 
and those which did reinsured a considerable portion of their business 
with English companies. In international trade rivalry, marine insur- 
ance plays a very prominent part. It is one of the three principal 
commercial facilities, the other two being an adequate merchant 
marine, and an adequate banking and financial machinery covering 
all countries with which we trade. “British commercial interests 
have long realized the advantages of codperation between these three 
complementary factors, since each can be made to serve and hasten 
the growth of the others.” ? Dr. Huebner estimated that in 1918 
foreign companies in the American market collected approximately 
$71,500,000 premiums on marine insurance, to say nothing of premiums 
on fire insurance, amounting to approximately $144,000,000 and on 
casualty, liability, and the various forms of inland insurance, amount- 
ing to about $35,000,000, making an annual insurance payment by us 
to foreign companies of about $250,000,000.2 During the World War, 
efforts were made—and met with some success—to increase the amount 
of marine insurance written by American companies. Since the con- 
clusion of the war, however, American companies have been unable 
to hold their own in competition with foreign companies, and now find 
their business slipping away from them. Great changes must come 
in our insurance laws, in our banking system, and in our foreign trade 
activities before we can expect to compete successfully with foreign 
insurance companies. 

The marine insurance policy differs from the so-called insurance 
certificate. The policy is usually a rather lengthy printed document 
describing in detail just what shipment is insured, the amount for 
which insured, the length of time the policy is to be in effect, the con- 
ditions and circumstances under which the insurer will hold itself 
liable for loss, the boat on which the goods are to be shipped, etc., and 
is usually issued in duplicate. The shipper is given a receipt by the 


1 Dr. S. S. Huebner in his Report on the Status of Marine Insurance in the United States, 
Washington, 1920, pp. 27-33, gives the following reasons for the dominance of the British 
companies: A world market of long development; a broader spread and broader reinsurance 
facilities; a close union with banking and shipping interests; freedom to combine or to 
form communities of interest; permission to write numerous kinds of insurance; a smaller 
tax burden; ease with which American insurance may be exported abroad; a smaller over- 
head charge; and support of home merchants and vessel owners. 

2 Huebner, op. cit., p. 10. , 

*Ihid, p. 12. 


164 







ial r 


NTN 





mad Road oat aa tax (and 


We 


sSNA SSIS SSE SE SRA 


STONY Oy 
me othe SAY HUB WV 





DOMESTIC AND FOREIGN EXCHANGE 


Fa No, [97419 


att Of § 
Op os errecteo adie a) 


Wiuicox, Peck & HuGHEes 


Lelruttie eras lay 944g 
Chis is to Certify, That on the Lonny helany of Wtag 1916 


there was insured with’ 


O) fis, Okano 
for account of Oy Carew fibers tue 


On Lanse (- 20) BALES COTTON, valued at sum insured, per 


ABC fy Sfitele Moc » Ys Lbeaty at and from 
AS BN NR *a ed 


It is hexeby understood and agre , in case of loss, such loss is payable to the 
order of i, Lrurcol surrender of this Certificate, which repre- 
sents and takes the place of the Polic nveys all the rights of the Original Policy- 
holder, (for the purpose of collecti aims for loss or damage), as fully as {f the 


property were covered by a special (po irect to the holder hereof, and is free from 
any liability for unpaid premiums. © 


on 





He 


ISHE 


28) VG 


¥. 


THEUSSUE 


es 


oBcuBLice 
pein 
mp Suz 


oi 
cet 


THE OTRERT 


ct 


GINAL SND 


Not valld unless countersigns By Authority of the Above Named Insurance Companies 


ORIG) 
n& CF WH 


X 


5 WHILLCox, PE as HUGHES 
Re KY KYA 
YY M CL, : YOY. 2 CJ PRESICZNT 


NRE te ES LT SERS ERE BLY A SR 








MARKS AND NUMBERS 


CZ 
Sy pune 











CLAUSES 


“This certificate is subject to the full terms of the policy in respect of being warranted ffee of capture, selrure and detentlo 4a 
the consequences thereof, or of any attem thereat, and also from all consequences of riot: i o insurre stilithe 
or warlike operations, ieee! re or vats ergy Tee of War.” i geese ee ctions, hostilities 

“With the exception of ri: in the Unite i om, fo risk covered hereun ‘ 
at war at time of ehipment.” ereunder on shore in any European country which is 

ON COTTON—To pay particular average on each ten bales as if separately insured, if amounting to three per cent. unless otherwise 
egreed, and on shipments to Europe to pay sca damage pickings claims without reference to series or amaunt. General Average and 
Salvage Charges payable according to Foreign Statement or per York/Antwerp Rules, if in accordance with the contract cf affreightment. 

Also to cover the risk of country damage on shipments insured hereunder to Europe, Japan, China, India or Manila, su! ject to 
eettlement at destination, in. dccordance with customs and usages of the port of destination, unless otherwise specified in certificate, but no 
claim Ei es of priestess age to cat es on rere siieene “5 the en States nor for any cost or expense in t of scch picking 
or reconditioning shall, recoverable hereunder. Country damage fs not covered on cost and freight! i local 
shioments to points in the United States or Canada or Mexico, freight shipments an sales, nor on 

LINTERS, Subject to 3% particular average on each bale, but free from claim for country 

Cotton pickings or grabbots, free of particular average unless the veosel be stranded, sunk, bur or in collision 

In the event of loss or damage to the cotton insured hereunder, immediate notice to be given to the companies as named hereon. 

Including risk of craft, &c., to and from the vessel, each craft of lighter being deemed a separate [nsurence, Held covered in case of 

*@eviation or change of voyage, or transfer to other steamers at a premium’'to be arranged, provided notice be given o2 receipt of advices, 
aie NS is Heats eunyeck fs the als moe rons of the policy, except so far as herein otherwise rerio. 

NOTI To conform with the Revenue wa 0 reat Britain, ia order to collect a claim ander mort 
stamped within Teo Days after its receipt in the United Kingdom < —e Ls 


RAE] REC ARN hia RY INT CARH RAR 


FIGURE 38—Insurance certificate 







RUN RUT SCNCNETRG 






















FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 165 


insurer showing the essential facts of the transaction. In case of 
occasional shipments an ordinary policy is issued, but when frequent 
shipments are made by the exporting firm, an “open” or “ floating” 
policy is customarily obtained. These open policies cover risks 
amounting to large sums of money and contain clauses which protect 
the goods under various circumstances as desired by the shipper. 
They do not contain any data relating to any one shipment, but, as 
each shipment is made, the insurance company indorses the required 
information thereon. An open policy runs for a given length of time 
or until the aggregate values of the shipments amount to the total 
sum for which the policy has been issued. Open policies are extremely 
handy for exporters because they enable the shippers to insure their 
goods without the necessity of continually resorting to the insurance 
office. When a shipment is ready to go forward, the exporter fills out 
the necessary blanks, which have been supplied him, just as though 
he were the insurance agent. These blanks are technically known as 
“insurance certificates” (Fig. 38). He makes as many copies as he 
needs for his bills of exchange, usually two, in addition to one copy 
for his own files and another for the advice of the insurance company. 
When the latter receives the “advice” copy it indorses the required 
data on the open policy, and enters the amount of the premium 
against the account of the exporter. The certificate contains a state- 
ment to the effect that a certain specific shipment sent on a certain 
designated vessel has been insured under a policy of certain number 
and that losses will be paid on such shipment in accordance with the 
terms of the original policy. Although much briefer, the certificate 
has all the force of the policy on which it is based. Special clauses may 
also be stamped on the certificate. Once a month or thereabouts, the 
exporter settles with the insurance company and pays the premiums 
charged against him. Such practice avoids delay in making ship- 
ments, since the insurance agent does not have to visit the exporter’s 
plant and write a policy every time a shipment of goods is ready to 
go forward. 

Marine insurance policies and insurance certificates are made out 
to the shipper or order and as a rule are indorsed by him in blank, 
just as is done in the case of the other negotiable instruments that 
constitute a documentary bill of exchange. 

It is customary to insure the cargo for from ten to twenty per 
cent more than the actual value of the goods shipped in order to 


166 DOMESTIC AND FOREIGN EXCHANGE 


cover “the costs of ocean freight, other incidentals, and possibly, 
sometimes, loss of the foreign importer in the non-arrival of goods 
on which he was depending.’ All the various kinds of risks insured 
against must be mentioned in the policy in order to secure the desired 
coverage. The cost of insurance depends upon the character of the 
risks insured, the nature of the goods, the point of destination, the 
character of the vessel on which the goods are shipped, etc. In normal 
times the rates will vary from one-quarter of one per cent on the in- 
voice value, provided the goods are being sent to one of the main 
European ports, to one and one-half or to even two per cent on ship- 
ments going to Oriental or tropical ports. 

Insurance may be effected by the shipper or by the importer. Very 
frequently the importer finds that he can obtain marine insurance 
much more cheaply at home than by allowing the exporter to secure 
it for him, in which case he notifies the exporter, and the latter, in 
place of the insurance certificate or policy, includes a declaration to 
the effect that “Insurance has been effected abroad.” ” 

Another important document is the invoice (Fig. 39), which is 


HENRY SMITH & COMPANY- 


San Francisco 
To J. Robinson & Co., January 15, 1919 
Liverpool, England 


50 bbls. Rosin 450 lbs. each @ £4 per bbl. 
Go Te’ Ke Tavernoola:.6 3+: eee ee eee E200 5a 


Marked J. R. & Co. 
Numbered 1 to 50 
Per S. S. ““Ocean Wave” via Panama Canal 





FIGURE 39 
Invoice 


usually only a statement of the goods shipped, although good commer- 
cial practice demands that it contain the name and address of the 
consignee as well as the name and address of the party to whom in- 
voiced, a full description of the goods, a statement of the number of 
‘boxes or packages, the method of packing, the number of articles in 


1 Hough, op. cit., p. 445. 

2 Cf. Chapter IX. The technical details of marine insurance may be learned by con- 
sulting any of the standard books on that subject. Cf. Huebner, S. S., ‘‘Marine Insur- 
ance’”’; Gow, W., ‘‘Marine Insurance”; Winter, W. D., ‘‘ Marine Insurance,’’ etc. 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 167 


each container, the marks on the boxes, the weight and dimensions 
of the cases, the price per unit of measurement, the total price of the 
shipment, discounts, the name of the steamer and route, the terms 
of sale, and such other information as may be necessary for the im- 
porter to identify the goods when they arrive.! Invoices should al- 
ways be numbered and signed and should include the cable code which 
the exporter is accustomed to use. It is the practice of some firms to 
include also a statement of extra charges that the importer is to pay 
and which have been included in the sum for which the draft has been 
drawn, but sometimes this latter information appears on a separate 
form. The number of copies and the language in which the invoice 
is made out must coincide with the legal requirements of the country 
to which the goods are being sent. 

A consular invoice is very generally demanded, especially by Cen- 
tral and South American countries, Cuba, Mexico, etc. (Fig. 40). 


AMERICAN CONSULAR SERVICE 
CONSULAR INVOICE 


(Place and date.) 
Invoice of ———_ purchased 
by ——-—__,, of 
from ———_——_____—Y——_, of 


to be shipped per 
FULL DESCRIPTION OF 
Marks, GOODS Price Total Consular 
Numbers, (N. B.—Always state the Per Unit Amount Corrections 
and cost of packing, and all or 
Quantities other costs, charges, and Remarks 
expenses) 


The above invoice is correct and true. 
(Signature of purchaser or seller or duly 
authorized agent of either signing in the 
name of his principal) 


1Cf. deHaas, op. cit., pp. 180-182. 


168 DOMESTIC AND FOREIGN EXCHANGE 


Declaration of Purchaser or Seller or Duly Authorized Agent of Either 





Ls 7. = x 
We 
of— io solemnly and 
truly declare that ee na na ann eo ns 
we are 


(Purchaser or seller) 

of the merchandise in the within invoice mentioned and described; that 
the said invoice is in all respects correct and true, and was made at the 
place named therein whence the said merchandise is to be exported to the 
United States of America; that said invoice contains a true and full state- 
ment of the time when, the place where, and the person from whom the 
same was purchased, or agreed to be purchased and the actual cost thereof, 
price actually paid or to be paid therefor; and all charges thereon; that no 
discounts or commissions are contained in said invoice but such as have 
been actually allowed thereon; that all drawbacks or bounties received or 
to be received are shown therein; that no different invoice of the mer- 
chandise has been or will be furnished to anyone, and that the currency 
in which the invoice is made out is that which was actually paid or to be 
paid for the said merchandise. 

s further declare - ——-—— 


W 


I Fhe : 
We further declare that it is intended to make entry of said merchandise 
at the port oi —————————————_n: the United States of America, 
Dated. at rrr 


ees SNE 
(Date) 


The signature to a declaration made by an agent should show the name 
of the principal, the name of the agent, and an indication of the authority 
by virtue of which the agent acts. 


FIGURE 40 
Consular invoice 


FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE 169 


It is similar in its content to the ordinary invoice, but at times con- 
tains additional information required by the laws of the importing 
country. The form is usually obtained from the consular officers. 
When the necessary number of copies (varying from one to seven) 
have been filled out, they are certified or sworn to before the consul 
of the country to which the goods are to be sent. A small fee, either 
a definite fixed sum, such as $2.00, $2.50, etc., or a percentage fee, 
such as one or two per cent of the value of the shipment, is paid the 
consul for certification. Such fees are in reality disguised import 
taxes. On the other hand, however, consular invoices greatly facili- 
tate the work of the customs officials of the importing country. 

A certificate of origin is sometimes met with in handling documen- 
tary bills of exchange. It is merely a certified statement showing in 
what country the goods originated, and also giving the name of the 
exporter and the consignee, and a description of the goods themselves. 
In some countries it is necessary for such certificate to be presented 
in order that the goods may be admitted to the importer’s country 
at a reduced tariff rate. The certificate is viséed for a fee by the consul 
of the country of destination. 

Some countries require an inspection certificate showing that the 
goods were in proper condition when they left the shipping point. 
This applies especially to meat and meat food products, processed 
butter, etc. Some countries (primarily British colonies) also require 
anti-dumping certificates, which are sworn statements to the effect 
that the goods are not listed at prices lower than those for which they 
are selling at home and that no unusual discounts are being given to 
the importer. Certificates of weight, analysis, etc., are also sometimes 
necessary. 

A documentary bill of exchange comprises one copy of each of the 
required documents. Care must be taken to have each set complete, 
free from erasures, corresponding in all details, and properly indorsed. 
They carry title to the goods, and consequently the banker who buys 
them must be careful that they contain or omit nothing that will im- 
pair the bill of exchange as a negotiable instrument in which he has 
invested his money. 

The above discussion holds true regardless of whether the exporter 
sells his documentary bill of exchange to the bank or whether he 
turns it over to the bank for collection. Very frequently the latter 
practice is followed when the discount rates are unfavorable and the 


170 DOMESTIC AND FOREIGN EXCHANGE 


exporter prefers to wait for the return of the funds after their collec- 
tion abroad, or when the consignee is unknown, or when the exporter 
is willing to allow the importer to take a portion of the goods from 
time to time and to pay for them in pro rata installments, or for some 
other reason. The bank then acts as a collection agent, and pays the 
money to the exporter as collected, minus its charges. The instruc- 
tions given by the exporter to the bank in such cases must necessarily 
be full and explicit as to just what the bank is to do under any and 
all circumstances that may arise. 


CHAPTER VIII 
TYPES OF FOREIGN BILLS OF EXCHANGE 


The means that are employed in paying bills abroad or in financing 
foreign trade or foreign travel may be roughly divided into five groups: 

A. Mail remittances, i. e., checks on foreign accounts, postal and 
express money orders, bank post or postal remittances, and bank 
drafts. 

B. Cable remittances, i. e., cables or telegraphic transfers. 

C. Those that arise in connection with the loaning of foreign money 
or foreign credit in the United States, i. e., the greater part of the so- 
called bankers’ long bills, including those used in connection with (a) 
currency or dollar loans, (b) loans in terms of a foreign money, and 
(c) “finance’’ bills. 

D. Those that are used for traveling purposes, i. e., the travelers’ 
check, and the travelers’ letter of credit. 

E. Those means that enable creditors to draw drafts on debtors 
for goods sold or services rendered or to collect some monetary claim, 
i. e., drafts drawn against sales of securities or drawn under a com- 
mercial letter of credit, authority to purchase, etc. 


A. Matt REMITTANCES 


Checks. The ordinary check drawn by the depositor on his banking 
account in terms of dollars, with which all are so familiar in domestic 
trade, does not function in foreign transactions. Lately, however, 
large American importing and exporting firms have developed a 
decided tendency to establish checking accounts, both demand and 
time, in foreign countries. This tendency has been encouraged by 
the very favorable exchange rates that have prevailed during the last 
few years. Today, when one of these firms desires to pay a bill abroad, 
it merely draws a check on its foreign account in favor of its creditor, 
just as it would on its own local bank account for a domestic payment, 
and forwards the check to the foreign party to whom it owes the money. 


The check is drawn in terms of the money of the country in which 
171 


172 DOMESTIC AND FOREIGN EXCHANGE 


the firm has its foreign account, and is payable at sight. In the es- 
tablishment of such foreign accounts, certain of the larger banks and 
some express companies have given active assistance by selling sight 
drafts drawn on the foreign accounts of the bank or express company. 
These drafts the American firm (or the bank or the express company 
acting on its behalf) forwards to the foreign correspondent along with 
copies of the signature of the firm, whereupon the foreign correspondent 
opens the account just as a San Francisco bank under similar conditions 
would open an account for a New York firm. More frequently the 
American firm deposits a sum of money with the American bank or 
express company, together with several copies of the signatures which 
are to be honored on the firm’s checks. The exchange dealer sends the 
signatures to the foreign correspondent with a request that an account 
be opened for the American firm and that the stated sum be deducted 
from the account of the exchange dealer on deposit with the corre- 
spondent and transferred to the account of the American firm. The | 
exchange dealer is paid for his services by the profit which he makes 
in charging the American firm a certain exchange rate for that portion 
of his foreign account which he has turned over to it, the rate charged 
being the ruling rate for sight drafts on the center in which the account 
is established. 

International or Foreign Postal Money Order. A method often em- 
ployed, especially by foreigners, in sending small sums abroad, is the 
international postoffice money order sold by the local offices of the 
U.S. Postoffice Department. The application blank must be filled 
out by the sender or remitter. The clerk takes the application and 
from the data thereon fills in the spaces on the money order itself. The 
money order is of three parts, one being the stub or receipt kept by 
the issuing office, the second being the receipt given to the remitter, 
and the third the order itself, which is also given to the remitter. The 
remitter sends the order to the foreign party, who presents it at his 
postoffice and receives, in money of his own country, the sum des- 
ignated. Suppose that the remitter wishes to send ten dollars to 
his mother in England. He fills out the application, the clerk con- 
verts the ten dollars into pounds sterling at the rate fixed by the U. S. 
postal authorities, and writes out an order for so many pounds, shil- 
ling, and pence. The English postoffice, on presentation of the order 
by the sender’s mother, pays the amount designated. 

The United States Government in 1920 had direct exchange con- 


TYPES OF FOREIGN BILLS OF EXCHANGE 173 


nections with fifty-three countries and indirect connections with many 
others. On some it is authorized to draw in the money of the countries 
concerned; on others it must draw in dollars and cents and the orders 
are converted by the local foreign postoffice into the money of the pay- 
ing country. 

The postoffice charges a fee for the issuance of the order varying 
in amount from three cents to one dollar for sums ranging from one 
cent to too dollars, depending upon the amount of the order and also 
upon the country to which the order is sent. There is a group of 
countries made up mostly of the smaller West Indian islands, Cuba, 
Canada, the Philippines, etc., on which the domestic form of money 
order is issued and for which the domestic rates are charged.! On all 
other countries the international money order form is used and a 
different set of rates is charged. A single foreign money order cannot 
be drawn for more than $100 worth of foreign money, although any 
number of such orders may be issued to a person. 

Inasmuch as the money order must be drawn on the more important 
nations in terms of the money of those countries, dollars must be 
converted into terms of that money. The postoffice authorities supply 
the local offices with a conversion schedule of rates. The following 
rates on the more important European countries were in effect until 
August 15, 1920: 


Rte st CTlitig yt siemens ore. Get ot $4.87 
Krona on Sweden, Norway and Denmark.. .26 9/10 
Beier Or roland Mire faeces 6 os obs .40 1/2 
Franc on France, Belgium, Switzerland, 
mary lire Ot Maly) te oe 05's oe ee 1.00 for 5.15 francs or lire 


During the early days of the World War, the market rates on the 
above countries, éspecially on England, reached such high levels that 
it was possible for bankers, speculators, and others to go to the post- 
office and receive, for example, a money order on England at a cost 
of $4.87 per pound sterling when the cost in the open market was $5.00 
or higher. To have continued the unlimited sale of orders at the then 
existing scale of rates would have meant serious financial loss to the 
government. Therefore, on August 3, 1914, the Postoffice Depart- 
ment instructed the local offices not to send more than $100 worth 
of foreign money orders to any one payee. This restriction remained 


1 Cf. footnote, p. 25. 


174 DOMESTIC AND FOREIGN EXCHANGE 


effective until January 21, 1915, by which time the rates in the market 
had returned to normal. The rates of conversion and the practices of 
the postoffice then remained unchanged until August 15, 1920, when 
the following schedule was issued by the Postmaster General, because 
the rates in the market had declined so greatly: 


Pound Stethne ves: sos ses tees eo ae $4.00 
Krona on Swedens ys. Gee 6 ce tte See .24 
Krona on Denmark and Norway........ {3 
Florin 2 Stes eo he ene Oe 38 
Franc on France, Belgium, and lire 
on Ttaly oo We Ah lien ote Se eee 1.00 for 10.30 francs or lire 
Franc-on Switzerland 4/25.) 5.) es eee 1.00 for 5.15 Swiss francs 


A further revision was made on November 15, 1920: 


Pound Sterkng 209 3.0: 3 Poa 5 ee ee $3.75 
Florin on Holland) oot on Pa ee 35 
Kronasonspweden iss csv key aene gee iirc ac meee ae Ve 
Krona'on Denmark and Norway. by.5 sae ee ee 16 
Franc on Franecé.and Belgium.) G7.. soe 13 francs for 1.00 
Layraon Dba iar, sv. oka eh eee ee 20 lire for 1.00 
Franc: On Sy iceriiiee: « «<5. 9.2m eee 5.15 francs for 1.00 


These revisions of the conversion table of the postoffice were neces- 
sary because the previous rates had afforded excellent opportunities 
for speculation and because also serious complaint was being made 
that the government was charging altogether too much for its money 
orders. The public until August, 1920, had to pay $4.87 (which rate 
had been fixed in 1880) plus a ten cent fee for a £1 money order at 
a time when express companies and banks were charging from $3.20 
to $3.50 and were getting the major portion of the business. The 
high rates, however, enabled the postoffice department to profit 
greatly, so that, in spite of losses arising out of unfavorable purchases 
of exchange,’ it made a profit of $1,242,079.08 on the foreign money 
order business during the fiscal year ending June 30, 1920. Approxi- 
mately $33,000,000 worth of orders were sold during that year.” 

The U.S. Postoffice Department sells more money orders on foreign 
countries than it is called on to cash against those countries. As a 

1The total loss amounted to $1,380,224.04. 


2 The extent of the business grew from $22,189.70 in 1870 to a maximum of $97,681,211.85 
in 1911. Since ro11 there has been a slight decrease in the amount of orders sold. 


TYPES OF FOREIGN BILLS OF EXCHANGE 175 

















consequence it has to go into the ae a 
open market and purchase ex- | Be erly 21 
change to meet its foreign indebt- Osi it: 2 i> 
edness thus occasioned.! This it _#% #2 & 


VIDS 


does by asking for competitive rm 
bids from the exchange dealers in 
New York. The exchange pur- 
chased in this way is then sent 
abroad to settle the obligations of 
our postal department to foreign 
governments. 

American Express Company Lim- 
ited Check. ‘The American Ex- 
press Company issues through its 
agents what is known as a “limited 
check” (Fig. 41). It is a form of 
three parts, the customer’s receipt, 
the order itself, and the agent’s 
stub. The customer keeps the re- 
ceipt and mails the order to the 
foreign party, who merely in- 
dorses and cashes it at a bank, 
hotel, store, or express office. It 
later finds its way back to the 
head office of the American Ex- 
press Company in New York City, 
where it is finally canceled. 

The check is somewhat similar 
to the postoffice foreign money 
order and was devised to compete 


pee 


ao 
* 
sued 





a 
N¥- 


“AMERICAN BXPRESS cogieg 

















Sas authorized Agent, pay this Cheque from our credit balarice, 











When countersigned by = es SS 


‘To the ordee of 











POUNDS 
STERLING 
HR 
TURKISH 






POUNDS 

nl Peson 

ant Pesee 
RUBLES. 


FIGURE 41—American Express Company limited check 









with it. The maximum amount dik 
for which the check can be issued oo in 
is limited to $100, although if a  . oo ee 
customer wishes to send more than  . _ fale 
fo . 
thatsum he may purchaseasmany ¢ | ##|. ale 
orders asmay be requiredtodoso. | | | 2 = || |i : 
1 During the fiscal year 1920 ourindebted-  ¢ & = § os. Fig e 
ness for foreign countries in this connection LC s & Be > & 23 8 afl 2 
amounted to approximately $13,000,000. be - — 





176 DOMESTIC AND FOREIGN EXCHANGE 


The checks are sold at the current rates of exchange, according to 
quotations supplied the agents (Fig. 42), so that the customer 


AMERICAN EXPRESS COMPANY 
Foreign Exchange Rates 
SAN FRANCISCO 
Good Only for Use 
May 24th, 1922 
Postage applies only on Foreign M/Os 
Checks M/Os Postage 


be England 4.45% 1o¢ 
te Ireland-Scotland 4.45% 1o¢ 
Francs France .0012. .0014 25¢ 
Francs Belgium .0844  .0846 25¢ 
Francs Switzerland 1912 I5¢ 
Lire Italy .0523 .0525 30¢ 
Kroner Norway .1840 .1842 15¢ 
Kroner Sweden .2590 =. 2592 15¢ 
Kroner Denmark .2150 . 2152 Is¢ 
Gulden Holland 3895 Is¢ 
Finmark Finland .0212. .0214 1s¢ 
$ Loc. Cy. Hongkong .6035 

Pesetas Spain .1605  .1607 25¢ 
Drachmas_ Greece .042I .0423 I5¢ 
Marks Germany .0038  .0040 25¢ 
Kronen Hungary .0013 .0013% a2s¢ 
Kronen Austria ,OOOII .ooor1ly as¢ 
Crowns Czecho-Slovakia .O192. 0194 25¢ 
Kronen Jugo-Slavia .0038  .0040 a5¢ 
Lei Roumania .007I  .0073 as¢ 
Yen Japan .4875 

FIGURE 42 


Foreign exchange rate list of American Express Company 


First column of rates applies to express foreign drafts and limited check; 
the second column to postal remittances; the third column to the 
postage charge on postal remittances 


is always able to purchase his remittance at a much better rate 
than in the case of the postoffice foreign money order. The offices 


TYPES OF FOREIGN BILLS OF EXCHANGE 77 


of the express company are usually more conveniently situated 
near the business district of the town than is the postoffice. Fur- 
ther, the express company sells not only through its own offices, 
but also through branch agents and local exchange dealers, such 
as banks, steamship companies, etc. It can also furnish orders on 
more foreign countries than the postoffice because it has thousands 
of correspondents scattered all over the globe. 

Bank Post Money Order or Postal Remittance. Closely akin to the 
foreign money order is the “bank post money order,” or “foreign 
postal remittance ”’ as it is sometimes called, originated by the Ameri- 
can Express Company in 1897. People in the outlying districts of 
foreign countries are unacquainted with the intricacies of checks, 
drafts, money orders, indorsements, etc., and much prefer to have 
the actual money sent them. Banks and express companies have 
developed a very unique device to make this possible. If the remitter 
goes to the office of the bank or express company and states that he 





FOREIGH MONEY 


N° 4100082 









He uncer s naeceee HOY EXCREMI AG FIFTY © 


WEL ESRR ANAC BURL DPEDEK, ROUEN, PREOMAK ANU COMER 


NOT NEGOTIABLE pare 


FIGURE 43 
American Express Company postal remittance 


wishes to put a certain amount of the actual money of a foreign coun- 
try in the hands of his family or relatives, he will be advised to use a 
postal remittance (bank post money order). This order is usually 
of four parts, viz., the remitter’s receipt, the agent’s stub, the notifica- 
tion to the payee, and the advice to the correspondent of the exchange 
dealer from whom the order is being purchased. To simplify the 
description of this interesting foreign exchange device, let us first 
consider the method and form issued by the American Express Com- 
pany for which, as it will be remembered, all express offices now act 
as agents in domestic and foreign exchange matters. 


178 






199. : 








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12 . 
i= | | 
4) } 4 
fo 
is | 
Bo 
i2 i 
= °° | 
< LC 
oo S | 
2 1EO, | : 
<™ i i 
zo Sin xing ji Afuo pred ag oy 
O ze 
23 Wwitiorwo 
feo = i YS. | 
Sa: L % | 
<2) H : H 
one | a 
eee... hlUCK 
mes | hl 
= 2 |. 
Gl 866 : i : 
= - § 
ye i : a ; : 
se i i | i 
ue _ 
fo 
ny Gi } : 
& 2 | 
ef | #& 
cS ; i ist 
go o- | o| 3 
BR B&F a 
CC 
$< j Pe ee) es ee ec 
S718 lita 
PSPS tte 
ete lee 
Poult 2 iit et lk 
PEtN At lle tig ge 
Masses |i je 1k 
(weeeis | (1144 1S oe 
Perse le Pia 
eoasiy, (ities ig 
(rig) leis hfe UE 
eis & | o4i ll 
ea re hate 
te gt ise 6hUGLE UUs 
oe elit te 
Ee SPS pee a Sy . 
QAagic¢cu<¢o se { 


ee Sire srs eevee pe ist Shapasicaas te | 





FIGURE 44—Postal remittance issued by bank through American Express Company 





DOMESTIC AND FOREIGN EXCHANGE 


The blanks are issued to the 
agencies in book form, each 
order being in triplicate and 
numbered serially. One of 
these is the remitter’s receipt, 
the second, the agent’s stub, 
and the third, the advice to 
the Foreign Order Department 
of the American Express Com- 
pany. No notification to payee 
is given to the remitter. The 
agent fills out the three parts 
at once by using carbon paper 
between the sheets. The same 
data thus appear on each, al- 
though each contains a printed 
heading at its top showing 
whether it is the stub, receipt, 
or advice (Fig. 43). He re- 
tains the stub, and gives the re- 
ceipt to the remitter. The re- 
mitter keeps the receipt, but if 
he desires to do so, he may for- 
ward it to the payee in the 
foreign country so as to advise 


“him that the money is being 


sent. The advice is forwarded 
by the agent to the head office 
of the American Express Com- 
pany in New York, which, in 
turn notifies its agent or cor- 
respondent, located nearest to 
the payee, to pay to the latter 
the amount of money desig- 
nated. The correspondent in- 
closes the exact sum of money 
in an envelope, registers it, and, 
through the postoffice or a 
messenger, sends it to the payee. 


TYPES OF FOREIGN BILLS OF EXCHANGE 179 


Sometimes a local postoffice money order is inclosed instead of the ac- 
tual money depending upon whatever method the correspondent con- 
siders will best serve the interests of the payee. When the payee 
receives the registered letter he signs a receipt which is generally sent 
back to the original issuing agent in the United States and through 
him turned over to the remitter thus assuring the latter that the 
money has reached its destination. 

The forms used by exchange dealers that sell exchange through the 
American Express Company’s service, i. e., banks, steamship com- 
panies, etc., have the name of the exchange dealer, instead of the name 
of the American Express Company, appearing on the blanks (Fig. 
44). They consist of two parts, the dealer filling out both parts at 
once by using carbon paper. The first part consists of the order and 
the remitter’s receipt, while the second part consists of the dealer’s 
stub and the advice which he sends to the American Express Company. 

The costs of a postal remittance are higher by two points on the 
exchange rate than for the limited check, plus postage, which ranges 
from ro cents to 30 cents according to the postal rates of the country 
- to which the order is being sent.! 

If the money is to be forwarded to a country upon which the com- 
pany quotes exchange rates to its agents and dealers, the sum in 
dollars that is to be sent is converted into terms of the foreign money 
on the basis of the conversion table furnished the agent or dealer by 
the New York office of the company and kept up to date by it.” The 
quoted rate includes a slight profit for the express company. But when 
exchange rates are not so quoted, the remittance is made out in dollars 
and is payable in the foreign country at the current rate of exchange 
for dollars in that country on the day that the remittance is paid, the 
conversion being effected by the foreign correspondent, who deducts 
his charges before paying over the money to the beneficiary. 

Of late the American Express Company has had to meet the com- 
petition of the larger banks and exchange dealers, who have also 
developed their own system of bank post remittances. The following 
is typical of the form commonly used by banks and exchange dealers 
(Fig. 45). It is made out in triplicate and none of the copies is negoti- 
able, just as was the case with the postal remittance of the American 


1 ‘The system depends for its life upon a facility provided by continental postoffices . . . 
that of marking the value of the contents of registered letters on the cover, and paying ad 
valorem postage which automatically insures it.” Guaranty News, September, 1919, p. 216. 

*Cf. p.376. 


180 DOMESTIC AND FOREIGN EXCHANGE 


Express Company. The original is mailed to the payee notifying him 
that the money will be forwarded; the duplicate is the remitter’s re- 
ceipt, while the triplicate is kept by the issuing bank for its files. The 





FOR. OEPT. 


S Bank Post Remitiaure < 


Los wSX 


M 








Address 





n 
= 
oo 
oO 
a 
a) 
° 
el 
fe 
°o 


California, U. S. A, 


will be transmitted the sum of 





for account of. 


» FOREIGN AMOUNT AMERICAN AMOUNT 
2 $2 
: 


ORIGINAL SEC NOTICE ON BACK HEAKOF 


















































=f 
= 
isc} 
= 
~—| 
51 
S 
° 
‘S 
Go) 
Zz 
8 
q 
iso) 
-o 
j=) 
bey 
oO 
= 
o 
a) 
EY 








FIGURE 45 
Postal remittance issued by bank 





eG FRX MNBL 
CABLE AODRESS—MERCHANTS LOSANGELES 









oe Merchants National Bank es 


OF LOS ANGELES 


Los Angeles, Cal.,. 






Ta 


AMOUNT 


YOURS TRULY 





FIGURE 46 


Advice to foreign correspondent in connection with bank post money order 


TYPES OF FOREIGN BILLS OF EXCHANGE 181 


issuing bank uses the following form of advice in notifying its foreign 
correspondent to pay to the designated party, by registered and in- 
sured mail, the sum mentioned and to deduct that amount from the 
account of the sending bank (Fig. 46). When a local country bank 
issues a postal remittance through another exchange dealer or jobbing 
bank, it employs the same forms in the same manner as above, but 
it does not notify the foreign correspondent bank. It notifies the ex- 
change dealer or jobbing bank through which it is issuing the postal 
remittance and uses the following form for that purpose (Fig. 47): 





RRR RON TR OC ORO 


t PRON. DEPT, : MONBLL A, 
USE SKFARATE SHEET FOR EACH COUNTRY—SEND US ORIGINAL AND DUPLICATE 


FOREIGN POST REMITTANCES 


Date ee 





| : i ( lk 


To Jie Merchants National Bank of Los Angeles, California | 


Gentlemen: eae © execute ake following bene: 



































| 
ae 
i ss SESS INS 


Total : (a $ 


Postage . . Orders @ g 
is i es oe : = ne an nt, 
' TOTAL $ Bonk _ 


be ‘ seers ee ; ‘ 


SORA OOS SI ESTE CLT DOTNET OPAC ITO NCOP OO age RS 








FIGURE 47 


Advice to jobbing bank in connection with bank post money order 


The exchange dealer or jobbing bank uses the same form as above 
(Fig. 46) in notifying its foreign correspondent of the issuance of the 
post remittance just as though it itself had sold the remittance to the 
customer. The larger banks, just as was true of the American Ex- 


182 DOMESTIC AND FOREIGN EXCHANGE 


press Company, act as wholesalers of exchange, while the local banks 
that draw through them act as retailers. The retailer charges what 
the traffic will bear, but always buys exchange at the rates sent out 
daily or weekly by the bank through which it sells. 

Before the upheaval and disarrangements caused by the Great War 
this system of forwarding money to foreign countries was “as nearly 
perfect as was humanly possible.” ! In normal times hundreds of 
thousands of such payments were transmitted to Europe weekly. The 
American Express Company alone in 1919 handled an average of 
10,000 such orders per week, while during seasons of heavy business 
it has been called upon to handle upward of 4,000 remittances daily. 
The Guaranty Trust Company of New York declares that “We have 
always felt that the financial regeneration of Italy, which was so notice- 
able from 1895 onward, was due in no small measure to the continual 
pouring in to that country in one unending stream of these small 
remittances which represented the savings of her faithful children 
who emigrated both to North and South America.” ? It is esti- 
mated that at least $100,000,000 was formerly sent annually to 
Poland by her emigrants, mostly by means of the bank post re- 
mittance. 

The breaking up of families, the changing of addresses, and all the 
confusion caused by the World War, greatly upset previous conditions, 
with the result that it has been difficult and in many cases impossible 
for the bank and express post remittances to function as satisfactorily 
as before. Undoubtedly, with the return of normal conditions in the 
late warring countries, the bank and express post remittances will re- 
gain their former usefulness. 

Bank Drafis. The two kinds of exchange most commonly pur- 
chased by American business firms and others for remitting money 
to parties in foreign countries are drafts and cables, both of which are 
sold by banks and express companies. In normal times they are 
available on any of the important trading countries of the world; war, 
of course, naturally interferes with customary practices. 

Most foreign drafts are drawn payable at sight, but drafts payable 
a certain number of days after sight or after date are not uncommon. 
Especially is the latter true of drafts sold by South American banks, 
usually drawn on correspondents in England payable g9o days after 
sight and sent by South Americans to their creditors even in countries 

1Guaranty News, op cit. 2 Ibid. 


TYPES OF FOREIGN BILLS OF EXCHANGE 183 


other than England.’ Foreign drafts are usually drawn payable to 
the order of the foreign party to whom payment is to be made, although 
they are sometimes drawn to the order of the customer or purchaser 
who then must add his indorsement before sending them abroad. It 
is customary to draw foreign drafts in duplicate or even in triplicate, 
but the former practice is the rule (Fig. 48). The copies are sent by 


 ciaaacaeaaneaneteeeenet ceteteaeecmmateememtertetettmmmecanesasttoeer teeters: “ ee —— 


= ‘ere rie : 


$ 
+ 
24 


eens, 
linn Baul os 


Lace 
UMITED STATES OF AMERICA 


Hus Angeles, Cal, eee S i 


Ses 













lauds Bank, Tt. 


a7, GORNHILL, LONDON, ‘e Cis 


London, ae x 





Yo 199 


atlionaal: Banks : 


Pata OF LOS ANGELES 
UNITER STATES QF AMERICA! 


x veges Cal. 1 Deane 5 





=i rochaute? 


ay 





_arrtr\r 





Blois Bank, Lin. 


AZ CORNHILL, LONDON, Ee ¢. , i ; 
HLont tort, England : oe 





FIGURE 48 
Original and duplicate bank drafts on foreign account 


separate mails as a precaution against possibilities of loss. The one 
that arrives first is paid and voids the remaining copy or copies. For- 
eign drafts are drawn on the foreign account of the issuing exchange 


1 This custom of selling three months drafts instead of drafts payable at sight arose in 
the South American countries because of the uncertainties of mail connections and the 
limitations of the foreign exchange market. If South American bankers sold sight drafts 
they might have great difficulty in finding sufficient cover to forward immediately, while 
in selling three months drafts they feel fairly assured of being able to forward cover before 
the drafts fall due. 


184 DOMESTIC AND FOREIGN EXCHANGE 


bank or on the foreign account of some domestic bank which acts as 
an intermediary for it in various foreign exchange transactions. The 
details of the practices followed in each case, as well as the forms that 
are used, differ to such an extent that to avoid confusion, some 


&-7 


The Anglo & London Paris National Bank 


of San Francisco 


STERLING 


EXCHANGE ON LONDON 


AW iro feet En le 


CED OTA Ol greece rete eerie eee eran eaten 


Ainount, Vote ees 
8 EE, EE 


Rate. eee 
Cost - 
Sane hranciSCo eee ee 1 OL eee 


PPUUP INS hh 9 Vcc te ee et ere ete eee 


FIGURE 49 
Application for bank draft on foreign account 





of the more commonly 
used forms will be de- 
scribed in detail. 
Considering first the 
case of the bank which 
issues drafts on its own 
foreign account let us 
say that a customer of 
a San Francisco bank 
asks for a sight draft 
with which to pay his 
creditor in London the 
sum of £1,000. The 
bank may have several 
accounts in London, 
but on that particular 
day it may be draw- 
ing heavily on its ac- 
count with the banking 
firm of Lazard Brothers 
in order to reduce its 
deposit with that com- 
pany. The clerk asks 
the customer to fill out 
a blank (Fig. 49) giving 
the name of the party 
to whom the draft is to 
be made payable, the 
amount in American 
or in English money 


that is to be sent, whether it is to be a demand bill, date bill or payable 
a certain number of days after sight, and by whom purchased (the 
customer’s name). ‘The clerk then glances at the rate board behind 
the counter on which the rates for the day are posted and notes that 
the rate on London which his bank is charging at that moment is $4.87 


TYPES OF FOREIGN BILLS OF EXCHANGE 185 


per pound sterling. If the customer is an old depositor of the bank, 
and because the sum is a rather large one, the rate will be shaved 
slightly, and he may get his draft at the rate of 4.8614. He therefore 
has to pay the clerk an amount of American money equal to $4.8614 X 
1000, or $4865. — 
On the other hand, The Anglo & London Paris National Bank 
if the customer of Sos Fyn 

wishes to send 
the equivalent of 
$4865 to his cred- 
itor in England, 
the clerk would cal- We beg to advise that we have drawn the following drafts on you 
culate how many | which kindly pay and charge to our account: 

pounds sterling | 
could be purchased 
for that sum at a 
‘rate of, say, 4.8614. 
The process would 
be one of divi- 
sion, i. e., 4865 + 
4.865 = £1,000. 
The customer 
would therefore be 
able to obtain a 
draft for £1,000 in 
return for $4,865 if 
the rate per pound 
were 4.86%4.} 

The draft is 
drawn on Lazard 
Brothers in dupli- 
cate, and both 
copies are given 
to the customer. He sends them by different mails to his creditor, 
who cashes at his own bank the one first received. This bank 
then forwards it to Lazard Brothers through the clearing house. In 
the meantime Lazard Brothers have received a statement or advice 


San PrancisCo wee ne Ae 


Dear Sirs: 





FIGURE 50 
Advice of issuing bank to foreign bank 


1The methods followed in converting dollars into English money and vice versa will be 
presented in Chapter X and Appendix III. 


186 DOMESTIC AND FOREIGN EXCHANGE 


(Fig. 50) from the San Francisco bank advising them that it has 
drawn the draft in question, and asking them to honor the same and 
deduct the amount from its (the San Francisco bank’s) account. After 
Lazard Brothers have cashed the draft and debited the account of 
the San Francisco bank, they notify the latter of that fact. 
Sometimes a customer demands a draft on a city in which the 
American bank has no correspondent. In that case the bank draws a 
draft on a bank in the designated city, which bank is a correspondent 
of the American bank’s foreign correspondent, and notifies the bank 
drawn on to present the draft to the latter for payment. The bank 


Ex, MON. BLA 


ee apereceaey caer ny (ee The Bi er chants National Bank 16-5 


OF LOS ANGELES 


Los Angeles, Cal., 
Zo the Banco: Novoant’ 1 eet ee eee 








ee ed eee 





Dear Sirs: Santanta ry Spain... i tin 


We have drawn upon you undermentioned drafis to which please give due honor on presentation to the debit of our account with 


YOURS TRULY 


FIGURE 51 


Advice to correspondent of foreign correspondent 


in such matters merely uses the correspondents of its foreign corre- 
spondent. To make the example a little more concrete, suppose a 
customer of the Merchants’ National Bank of Los Angeles asks for a 
draft on Santander, Spain. The Merchants’ National Bank has as 
its correspondent in Spain the Barcelona branch of the Royal Bank 
of Canada. The Banco Mercantil of Santander is the local corre- 
spondent of the Royal Bank of Canada. The Merchants’ National 
Bank of Los Angeles draws a draft on the Banco Mercantil and hands 
it to the customer. It then fills out an advice in duplicate, similar 
to the following (Fig. 51) and sends the original to the Banco Mercan- 


TYPES OF FOREIGN BILLS OF EXCHANGE 187 


til, asking that bank to honor the same and to present it to the Bar- 
celona branch of the Royal Bank of Canada. The duplicate copy of 
the advice is sent to the Royal Bank of Canada so that it may be 


The Royal Bank of Canada 


BARCELONA, SPAIN. 
LP/IS January llth 1922 
THE MERCHANTS NATIONAL BARK 
of Los Angeles 


LOS ANGELES (California) 
Dear Sir: 
We have debited your account with the following drafts drawn on 
ourselves or on our correspondents: 














| AMOUNT OF DRAFT COM MIS8ION 
i 





DRAFT NO. BRANCH DRAWN BY PLACE DRAWN ON 





PESETAS PESETAS 


5013 Yourselves 
4a 9 





58,436.65 

















wp B 187 8 5000-10 <38- 














Yours truly, 


"2... Manager. 





FIGURE 52 
Advice to issuing bank by foreign correspondent 


advised of the transaction. The draft will subsequently be presented 
to the Banco Mercantil, which will cash it, and then forward it to 


188 DOMESTIC AND FOREIGN EXCHANGE 


the Royal Bank of Canada at Barcelona, where the amount, plus 
charges if any, will be deducted from the account of the Los Angeles 
Bank, and the latter advised to that effect. (Fig. 52). 

There are two other methods by which a bank may issue a draft on 
another bank with which it has no account. First: Suppose that Jones 
in Chicago goes to his bank and asks it to sell him a draft on Rome. 
It may have no account in Rome, but it has one in London with Bar- 
clays, and it also knows that the Banca di Italia of Rome has an ac- 
count at Barclays. It can therefore sell a draft to its customer in lire 
drawn on the Banca di Italia of Rome, notify the latter of that fact, 
and ask it to reimburse itself by drawing a draft covering the trans- 
action on the Chicago bank’s account with Barclays. The Chicago 
bank will also notify Barclays to honor such a draft and deduct the 
amount from its account. The Chicago bank, however, runs the risk 
that the dollars it receives for the lire draft on the Banca di Italia may 
be less in amount than the dollars that will be required to replenish 
its sterling account at Barclays after Barclays has deducted the reim- 
bursement sterling draft of the Banca di Italia. Second: Say that 
the Banca di Italia has an account with the Chicago bank, but that 
the latter does not have an account with the Banca di Italia. Suppose 
Jones requests that the Chicago bank sell him a draft in lire on Rome. 
The Chicago bank issues the draft on the Banca di Italia and advises 
it of that fact, suggesting that it reimburse itself either by drawing 
a dollar draft on it (the Chicago bank) and selling the draft in the local 
(Rome) market, thus getting its funds in Rome, or by merely au- 
thorizing the Chicago bank to credit its account, on deposit with the 
Chicago bank, for the amount in question. 

When local banks that have no foreign banking accounts or corre- 
spondents sell foreign bank drafts through the agency of banks that 
act as exchange jobbers, the practices followed and the forms used are 
quite different from those described above. The jobbing bank sup- 
plies the local bank with the needed forms upon which the name of 
the retailing local bank is printed. These forms are bound in a book or 
pad, are serially numbered, and usually consist of four parts, although 
at times of two or of five parts. It also supplies a list of the foreign 
banks upon which drafts may be drawn. Daily or weekly the jobbing 
bank forwards the issuing bank a rate sheet containing the rates at 
which the issuing bank is authorized to cover its drafts, i. e., remit to 
the jobbing bank for drafts which it draws (Fig. 53). If the rates 


TYPES OF FOREIGN BILLS OF EXCHANGE 


change noticeably, as has often been the case since 1914, the jobbing 


The Merchants National Bank 


No. 104 





OF<OS ANGELES 


FOREIGN EXCHANGE RATES 


189 


GOOD ONLY FOR TODAY DATEMay. 5 1922. 





COUNTRY 


AUSTRIA 
BELGIUM 


BULGARIA 


CZECHO-SLOVAKIA| PRAGUE 


DENMARK 
FINLAND 
FRANCE 
GERMANY 
GREAT BRITAIN 
GREECE 
HOLLAND 
HUNGARY 
ITALY 
JUGOSLAVIA 


NORWAY 
POLAND 
PORTUGAL 
ROUMANIA 
RUSSIA 
SPAIN 
SWEDEN 
SWITZERLAND 
CANADA 
MEXICO 
Ome 
INDIA 
JAPAN 
AUSTRALIA 





BUYING RATES; ENGLAND 4-42 


*® App To EACH BANK PosT ReEMitTe 
TANCE 25 CENTS FOR POSTAGE, 
AND IN CASE OF CABLE TRANSFEA‘ 


THE COST OF CABLE, 











SELLING RATES FoR LIMIT + 







PRINCIPAL CITY IcurRENCY CHECKS ON CABLE®| IN THE 
Principal City| Other Places |" A%S75"9 | AGGREGATE 


ano B.P.R. 


Kropen .Oo13 .O13 .013 

























VIENNA 
ANTWERP: 
SOFIA 


France 8.45 8.46 8.47 
Levs -78 76. -77 
Kronen 1.98 1.96 1.97 
COPENHAGEN 
HELSINGFORS 


Kroner | 21.28 21.33 21.38 
Finmarke 2.08 2.09 . 2.10 













































PARIS Francs 8.20 9.21 9.22 
BERLIN Marks -36 3635 3635 
LONDON Pounds 4.44 4.445 | 4.4435 
ATHENS boat 48s 4.58 | 4.87 
AMSTERDAM | Gaiters [38-38 | 38.40 |a8.45_ 
BUDAPEST Rronen 133 1335 1335 
ROME. Lire 5.37 | 5.38 | 5.39. 
BELGRADE wince 1.47 1.49 1.49 
ZAGREB Kronen 36% .37% 37% 
CHRISTIANIA | kroner | 18-63 18.70 |18.78 
WARSAW Make 02% .O2% 
LISBON Recnice | 8:38 8.20 | 8.25 
BUCAREST Lei .73 :74 .78 
PETROGRAD Roukles NOT |QUOTED 
BARCELONA Pesetas | 18-60 -| 13.62 | 18.68 
STOCKHOLM Kronor «| 23-90 | 25.98 | 26.00 
ZURICH Faces 19.40 | 19.42 | 19.48 
MONTREAL Dollars | 98-358 | 98.38 |98.60 
MEXICO CITY | pesos | 49-80 | 50.00 |50.80 
HONGKONG loc. Cur..| 37-00 B7.80 
CALCUTTA Rupees | 28-80 | 28.73 | 28.75 
YOKOHAMA Yen. | 47.78 | 48.00 | 48.25 
MELBOURNE | Pounds |. 4-44%| 4.48 4,48 





France 9-98. —— Germany CANADA 


For other Countries quotations furnished on application. 





FIGURE 53 
Exchange rate sheet 


+. For RATES ON AMOUNTS IN 
EXCESS OF ABOVE LIMITS. 


I1N- 


QUIRE BY PHONE OR TELEGRAPH, 
oe 


bank may see fit to change its quotations by telegraph. The issuing 


bank is supposed to draw at the latest quoted rate, although it is not 


yep yueq Jo wi10f y1ed-mojy Jo odAT—+S aunoly 








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RAW Ils SOLE A : Ee : 
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, “SiNIHD “ONO OHO : : pa $0, 
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b4 S x : “ OOMLIKRVEA NVS 
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PVE RLS PY Pedy Pliny Dk AVIS 2RORDIM AIH ONE UNVIS SHA Nt Td BAWSIe “LayYKO ONINESI NO! 
< _mueg [GUOHEN URDIIULY su], : 











“SSILON LINVLILBOGNI | 
‘ | 


Igo 


TYPES OF FOREIGN BILLS OF EXCHANGE IgI 


unusual for it to disregard instructions and draw at a previous rate 
which may be slightly more favorable to it. Disputes frequently arise 
between the issuing bank and jobbing bank over this matter. The 
issuing bank on its part may charge its customer any rate that the 
traffic will bear, merely being certain that the rate charged is above 
the rate at which it will have to cover with the jobbing bank. It is 
customary for the issuing bank to charge about one per cent more than 
the rate quoted by the jobbing bank. 

There are a number of different kinds of forms used that are of four 
parts. The limits of space preclude our discussing any but those that 
are the most typical. In the form above (Fig. 54) the draft is drawn 
only on a designated foreign bank and in a designated foreign money. 
The original and duplicate drafts constitute the right-hand portion 
of the blank. The name of the issuing bank is not printed on the form, 
but is stamped in when its officers sign the draft. The lower left-hand 
portion of the form is retained by the issuing bank as its record of the 
sale. The upper left-hand portion is the advice which the issuing 
bank must send to the jobber, notifying it of the amount of the draft, 
when drawn, the name of the payee, and also as to what rate of ex- 
change and in what manner the issuing bank is covering (paying the 
jobbing bank), i. e., whether by check or by asking the jobbing bank 
to debit its (the issuing bank’s) account. The jobbing bank in its 
turn sends an advice to the foreign bank and asks that its (the jobbing 
bank’s) account be debited accordingly. 

In another four-part form (Fig. 55), the draft is issued in duplicate 
and bears on its face the name of the issuing bank and also the em- 
blem or monogram of the jobbing bank. Both of the copies are given 
to the customer. The lower left-hand portion is the issuing bank’s 
stub or record, while the upper left-hand portion is the advice which 
the issuing bank forwards to the jobbing bank. The latter notifies 
the foreign bank by means of an advice as in the examples given above. 

Sometimes the issuing bank is asked to sell a draft on a correspondent 
of the foreign correspondent of the jobbing bank. The practice fol- 
lowed, so far as the issuing bank is concerned, is the same as in the ex- 
ample cited above,’ but it becomes necessary for the jobbing bank to 
notify not only the foreign correspondent but also the bank on which 
the draft has been drawn as to the details of the transaction. To cite 
an example: Let us say that the First National Bank of Pasadena, 


1Cf. pp. 188-101. 


yep yueq Jo wo; yred-moy Jo odAT—SS aUNoIy 





t 


ua 


oR ace cokes sn nt sng ney 


Q juno220 moh sof umoip eS 


ony $0] 


é 


ms ned SUD LaH 2 


2 


19 


TYPES OF FOREIGN BILLS OF EXCHANGE 103 


California, has sold a draft through the Merchant’s National Bank of 
Los Angeles on the Banque Fédéral, Vevey, Switzerland. The latter is 
a correspondent of the Credit Suisse, of Zurich, which in its turn is a 
correspondent of the Merchants’ National Bank of Los Angeles. The 
First National Bank of Pasadena will, on selling the draft, notify 
the Los Angeles bank to that effect. The latter will fill out the follow- 
ing form (Fig. 56) usually, though not necessarily different in color 






“tn Goat mine ge Merchants National Bank 


Zurich 





OF LOS ANGELES 


Loasw/ngeles, Cale eee ee eee 922s 


ey 








To the___ Banque-Pedera), Yevey,—Saitzer 












Our friends____._._ The Virdt Hagfional Bank of Pasadena, Calif. eee eae ae 
have drawn upon you the undermentioned drafts to which please give - due honor ori ri presentation to the debit “of ¢ our account with 








——-~-. Credit-Suisse,Zorich _____ 








AMOUN 





- YOURS TRULY 


FIGURE 56 


Advice to correspondent of foreign correspondent 


from the form above mentioned (Fig. 51). This form or advice will 
be made out in duplicate, the original being sent to the Banque 
Fédéral and the duplicate to the Credit Suisse. The Credit Suisse 
will not wait until the arrival of the draft before debiting the account 
of the Los Angeles bank, but will debit the latter’s account as soon 
as the above advice is received. The draft may be presented several 
days or weeks later, so that in the meantime the Credit Suisse has the 
use of an amount of money equal to the face value of the draft. This 
is the general custom of all European banks, excepting only a few of 
the English banks, which debit the correspondent’s account only when 
payment of drafts is made. 

Certain of the above forms do not provide a purchaser’s receipt. 


DOMESTIC AND FOREIGN EXCHANGE 


194 


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Sis OQ tag 





BAM AG BAYH 





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OL 3ADIAGY _ dO NOILOSLOUd YaGNN NMVHA : 





oer Sh Sereno ene onte nee 


anis 


SESS RETR RR Bi Se Ra 





TYPES OF FOREIGN BILLS OF EXCHANGE 195 


It is the practice of every bank however, to give the customer a receipt, 
using a printed form for that purpose, stating the name of the payee, 
the amount of the draft, and other necessary data. 

In the case of the five-part form, which has but lately come into 
use in the foreign exchange field, the form is divided horizontally into 
two equal parts (Fig. 57). The draft itself constitutes the right-hand 
portion of the lower half, and the purchaser’s receipt the left-hand por- 
tion. The draft bears the name of the issuing bank and certain other 
marks or emblems which enable the foreign bank readily to recognize 
the identity of the jobbing bank. The upper half of the form is divided 
into three parts; the left-hand portion is the stub or record of the issu- 
ing bank, the middle portion is the advice that is mailed to the jobbing 
bank, and the right-hand portion is the advice that is mailed by the 


THE FIRST NATIONAL BANK OF SAN FRANCISCO 
NoA80_ San Francisco, Cal., 


For value received from 


We agree to write today to our correspondent ioe sal La 3 EE EE 
oredit ;,_. :O* 

to nay to (less expenses) et eee 

the sum of RA Gi as Bete Weed oe = BR ee TE 


without responsibility on the part of this bank for losa or delay in transmission. 


ET: ee aE ew Seen Tee 
THE FIRST NATIONAL ‘BANK OF SAN FRAN: co 
ow ra 
eZ en 


(OT eee ot be Same} reer ys re 
07.83-8-15-16.500 ~<Assistant Cashier 


Commission 


z 
4 
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Wl 
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W 
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& 
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etal 
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Receipt for letter of delegation 


issuing bank to the foreign bank upon which the draft has been drawn. 
In this case the issuing bank itself notifies the foreign bank. A slight 
modification of this form, as used by some jobbing banks, lies in the 
fact that the issuing bank is required to send both advices to the job- 
bing bank which in its turn then forwards the advice to the foreign 
correspondent. 

Letter of Delegation. Under the disturbed conditions brought about 
by the World War, one could not be certain that a draft, postal or 
express order, or other form of exchange ordinarily exployed in remit- 
ting money abroad, would reach its destination,’ so that resort was 


1 The real cause for the wide use of the letter of delegation was the announcement of the 
British Government in 1916 that it had placed all negotiable instruments destined to enemy 
countries on the absolute contraband list, and subject to seizure. A letter of delegation is 
not a negotiable instrument and therefore could be safely used. 


a 


s 
#55 
‘ 


196 DOMESTIC AND FOREIGN EXCHANGE 


had to the “mail transfer” or “letter of delegation,” which became 
very popular as a means of sending funds to certain sections of Europe 
(Fig. 58). Instead of issuing a foreign draft, the American exchange 
dealer simply writes to its foreign correspondent requesting it to pay a 
designated sum of money to a specified person or firm and to inform 
the latter that the money is being paid at the request of the sender. 
The letter of delegation is sent in duplicate, so that there is reasonable 
certainty that at least one copy will reach the foreign correspondent. 
A copy of the letter or a receipt is given the purchaser, who may for- 
ward it to the payee to advise him of the method and the amount 
of payment. The letter of delegation had been used to some extent 
before the World War, but primarily in connection with the establish- 
ment of bank credits.' Not being a negotiable instrument, it is not 
subject to the stamp taxes usually imposed by foreign governments 
on negotiable instruments. 


B. CABLES 


Cables. Cables or telegraphic transfers (commonly abbreviated in 
foreign countries to “T. T.’’) are, technically speaking, not bills of 
exchange because they are not negotiable instruments. Nevertheless, 
they are a form of exchange because they are a credit means of paying 
bills abroad. They have played an increasingly important part in our 
exchanges during and since the World War, following the depreciation 
in the exchange rates on foreign countries. A cable, as may be sur- 
mised, represents the “cabling of money” to a foreign payee when 
occasion renders it advisable or profitable to use that means of making 
payments. “Cabling money” is a misnomer, because no money is 
sent via the route of the cable. Money is paid to the exchange dealer 
in the United States, and he cables his foreign agent or correspondent 
to pay out a designated sum to a specified party. 

The customer who wishes to purchase a cable fills out a short appli- 
cation blank, or the clerk does it for him, giving his name, the amount 
in American or foreign money that is to be cabled, and the name and 
address of the payee (Fig. 59). The application is frequently filled 
out in duplicate and a copy given to the remitter as a receipt. The 
clerk converts the American money into terms of the foreign money, 
or vice versa, depending upon whether the customer states the sum 
that he wishes to send in terms of foreign money or American money. 


1Cf. pp. 298-299. 


TYPES OF FOREIGN BILLS OF EXCHANGE 197 


The conversion will be made at the cable rate for that day. The cable 
rate is always higher than the rate for demand or for time drafts. 
The reason, as will be explained more fully in Chapter X, is that in 
the case of a cable transfer the foreign account of the exchange dealer 
is debited within a few 
hours after he has sent 


the order, and he thus 
loses a number of days’ 
interest that he would 
otherwise have gained 
had the customer pur- 
chased a draft and for- 
warded it by mail. 
The costs of the cable- 
gram message are paid 
by the customer. The 
profit to the exchange 
dealer comes out of 
the cable rate that he 
charges. The dealer 
does not hold himself 
“responsible for any 
delays, mistakes or 
omissions which may 
happen in the trans- 
mission of the message 
or for its misinterpre- 
tation when received.” 
In a large foreign ex- 
change department, one 
clerk will take the or- 


Thie Anglo & London Paris National Bank 


of San Francisco 


CABLE TRANSFER 
To be placed to the Credit of 


ee ES FOES 19 einem nn nese eT et este ramenneneReet areas st ic nenness SRO ECemeenenmeadetst seencere———eneneeeene On eERerenne Renna erErNAnEss 


‘AOC rese tee eee re ee ee ee et ee eR 


At the Office of MESSRS. LAZARD BROTHERS & CO., LONDON 
Or eA COSCO feet ee a ora ee 


Amount - 


Cablegram - 
Total 


DETIG LATICISCOS Serene ee eee ee ee een ay 191 


Signature 


Purpose of 
Remittance 





FIGURE 59 
Application for cable transfer 


der, make the conversion, fix the charges, and receive the money from 
the customer while another will prepare the message in code form. A 
code is always used so as to save cable charges and also to guard 
against possibility of loss through wire tapping, etc. Test words at the 
beginning or at the end or at both the beginning and the end of the 
message are commonly employed for additional safety. During the 
World War the exchange operations in New York were greatly upset 
because code messages were forbidden by the Allies who were fearful 


198 DOMESTIC AND FOREIGN EXCHANGE 


of German spies. Cables may be “unregistered” or “registered.” If 
a firm frequently sends cable exchange, it may register the full name 
and address of the payee firm with the exchange dealer, who sets aside 
a code word covering these data and forwards it to the paying office 
or correspondent abroad. Then when the American firm wishes to 
send a cable to that firm, the one code word alone will suffice for the 
name and address of the payee. Such “registered’’ remittance 
usually costs about one-half the regular rate charged for the unregis- 
tered cables, which, as may be inferred, do not have the name and 
address of the payee or correspondent registered with the exchange 
dealer. Brooks! gives the following example as illustrative of a 
registered cable transaction: 


“The firm of H. J. Meyerfield and Co. of Chicago wish to have two thou- 
sand five hundred pounds sterling paid to Johnson, Gladstone and Co., 
153 Threadneedle St., (E. C.), London, England, for their account. 

“The message given to the telegraph company for transmission would 
be as follows (cipher words are fictitious): 

“NETIPROV LONDON MURTIER MYERSON MARDADIE, 

“Translated, these cipher words would mean: 

“(NATIPROV)—To the National Provincial Bank of England, Ltd. 

“(LONDON)—London, England. 

“(MURTIER)—Pay to the person(s) named in this cablegram. 

“(MYERSON)—Johnson, Gladstone and Co., 153 Threadneedle St., 
(E. C.) London, for account of H. J. Meyerfield and Co., Chicago, IIL, 
U. S. A. (Registered). 

“(MARDADIE)—(£2,500) Two thousand five hundred pounds ster- 
ling.” 


The American Express Company has a combination “Express 
Money Order and Cable Money Order” that is unique. An ordinary 
foreign money order is issued with the words “By cable” stamped 
across the face of the advice which is mailed to the head office of the 
company in New York. When the advice has been received in New 
York the company immediately executes the cable as requested. 

When a cable is sent from an inland point in the United States to an 
inland point in a foreign country, the telegraph charges, both here 
and abroad, are added to the cable charges. 

At various times during the World War the larger part of our foreign 


1“ Foreign Exchange Textbook,” p. 157. 


TYPES OF FOREIGN BILLS OF EXCHANGE 199 


remittances were made by cable because the mails were so uncertain.! 
Since that time, the very low exchange rates which prevailed and 
the possibility of their falling even lower, caused many merchants 
to resort to cables in the hope of effecting a saving on their foreign 
payments. If the merchant in New York buys a draft with which to 
pay a bill in Paris, he must send it by mail about nine to twelve days 
before the time when payment is due. On the other hand, if he thinks 
that the firm can make better use of the money for that length of time 
by waiting and then buying a cable, or if he thinks that the rate on 
Paris is likely to drop so that he will be able to buy a cable nine or 
twelve days hence at about the same rate that he would have to pay 
immediately for a sight draft, he will consider it to his advantage to 
wait and purchase a cable. Even in normal times circumstances arise 
that make it profitable and advisable for a firm to buy cables rather 
than sight drafts.” 

Exporters who desire to obtain immediate use of funds due them 
from foreign merchants will frequently advise the exchange dealer, 
to whom they have given their drafts and documents for collection, 
to have the funds remitted to them by cable. An exporter may also 
instruct the foreign purchaser to place the funds covering the trans- 
action in a foreign bank to his (the exporter’s) account. He may then 
go to his local bank and sell his foreign account to it, using the cable to 
instruct the foreign bank to place the money to get credit of the bank 
to which the account has been sold. 


1 “‘ Because of the uncertainties of the European mails, bankers last week transacted more 
business with Amsterdam by cable than by check, customers being willing to meet the 
additional expense for the sake of more certain transfer of their funds. The seizure of mail 
for Holland in recent weeks by British authorities has been the chief factor in expanding 
cable business. ... Bankers say that complaints of non-delivery of letters containing 
drafts caused so much embarrassment to clients that many of them have declined to send 
funds through checks to the Netherlands and Switzerland, even though the due date lies 
several weeks in the future. . 

““So difficult have means of communication between this country and Amsterdam be- 

come, bankers say, that clients have found recently that it is safest to allow on cabled 
remittances nearly as much time for delivery as though a check had been sent through 
the mails in ordinary times. Frequently as much as five days elapse in transmission.” 
Annalist, March 6, 1916. 
’ 2 The continued fluctuation in foreign exchanges during the past year is largely re- 
sponsible for the increased use of cable transfers for the meeting of obligations maturing 
abroad—debtors apparently waiting until the last possible moment to make their remit- 
tances, in the hope of getting a better rate. 

‘“‘Even in the days of more stable exchanges there were many possible situations in which 
American firms with obligations abroad would find it to advantage to remit by cable transfer, 
and such occasions will still arise when the recovery of the exchanges commences, unless 
it is far more rapid than is to be expected at present.” Foreign Trade Bulletin of the Amer- 
ican Express Company, September—October, 1919. 


200 DOMESTIC AND FOREIGN EXCHANGE 


Not only do banks, express companies, and cable or telegraph 
companies sell cables to the public, but they also buy and sell cables 
among themselves. Banks buy a large amount of cables from each 
other for the purpose of meeting obligations abroad, such as drafts 
that are falling due ! or to cover cables that they have sold to others 
even though with insufficient funds in their foreign accounts to meet 
the amount sold. At times they also sell heavily to each other in order 
to bring their funds back home when needed for more profitable in- 
vestment or to meet some pressing financial need. 


C. BANKER’S LONG BILLS 


Banker’s long bills are drafts that are issued by a banker upon a 
foreign banker, running usually for ninety days, although drafts of 
sixty days usance are not uncommon. They are issued for a number 
of purposes but primarily to enable foreign bankers to loan money or 
credit in the United States, either on their own initiative or on that of 
the American banker. 

Long Bills in Ordinary Course of Business. In our discussion of 
banker’s foreign drafts 7 we stated that it is not unusual for a bank 
to sell a sixty or a ninety day draft to a customer who may. wish to 
pay for goods which have been purchased abroad. If he purchases a 
ninety day sight draft on some foreign bank, it will be necessary for 
the party receiving it to have it accepted at the foreign bank. The 
payee may then hold it until it matures or he may get his money 
immediately after its acceptance by discounting it in the open market. 
A date bill may also be used in the same manner and for the same pur- 
pose. The reason why the customer purchases a long bill instead of a 
demand bill is that he may be able thereby to save on the exchange 
rate, the rate for long bills always being lower than that for de- 
mand bills because the bank has the use of the money during the in- 
terim. Although the purchaser, on the other hand, loses interest on 
his investment in a long bill, nevertheless he gets back a portion of it 
through the lower rate which he pays for the bill. It may also happen 
that the customer has to remit to some market upon which there is a 
small amount of exchange available, and so, because he cannot always 
be sure of getting demand exchange when he needs it, he purchases a 


1It is not unusual for dealers to sell demand drafts and then within a few days, just 
before the sight drafts reach their destination, to cover by going into the market and pur- 
chasing cables from other dealers. 

2 Cf. p. 182. 


TYPES OF FOREIGN BILLS OF EXCHANGE 201 


long bill instead. Such long bills may be sold by the bank against its 
account already on deposit with the foreign banker or against remit- 
tances of commercial “payment”? bills which the banker has purchased 
but which as yet have not matured. As will be seen later,! the banker 
learns from experience just about how many of the “payment”’ bills 
which he has purchased will be taken up or paid under rebate at ap- 
proximate future dates. On the basis of his calculations he thinks 
that he will have a certain amount on deposit in his foreign account 
sixty or ninety days hence, and therefore feels that he can with safety 
sell his own long bills against the same. If the “payment”? bills are 
not taken up by the dates that he has figured on, he will of necessity 
have to resort to other means of providing funds out of which to meet 
his long bills when they fall due. 

Long Bills in Loaning Operations. The sale or purchase of the type 
of banker’s long bill just described has, as is evident, nothing whatever 
to do with the loaning of foreign funds in the United States. Yet it 
is in connection with this latter matter that the banker’s long bill plays 
its most important part. Not only have foreigners, especially the 
English, been very heavy investors in American stocks and bonds,— 
which really amounts in the end to their loaning large sums of money 
to American industries—but foreign banks, principally the English, 
for years previous to 1914 loaned large sums of money for short periods 
of time to American banks and also, through them, to American firms 
with which many a financial deal of importance was consummated. 
These loans were customarily made by means of a banker’s long bill 
of one kind or another, running usually: for ninety days, and at times 
renewed for a like period. Since 1914, however, the foreign bankers 
have had such pressing needs for funds at home that they have been 
borrowing very heavily from us, and the long bill no longer functions 
as prominently as of old in our exchange markets. 

The initiative in negotiating these foreign loans may be taken 
either by the foreign bank, by the American bank, or by both. The 
foreign bank may note that the rates of exchange and the money rate 
in the American market promise profit on such a venture, and it there- 
upon notifies the American bank to loan a certain amount of money 
for it in the American market. Or it may be that the American bank 
surmises that the favorable exchange rates on the foreign country 
offer an opportunity to borrow profitably from the foreign bank by 


1Cf. pp. 495-496. 


202 DOMESTIC AND FOREIGN EXCHANGE 


means of an exchange transaction, or it may need the money to bolster 
up its legal reserves, or to float some stock and bond deal. Still an- 
other possibility is open, i. e., both institutions may enter into the 
transaction on the basis of a “joint account” whereby each party 
is to share equally in the profits or losses. Each of these arrange- 
ments requires a separate explanation. 

Suppose that Barclays of London takes the initiative and decides 
to loan £100,000 in the New York market through its correspondent, 
the Fifth National Bank. It notifies the latter by cable of its decision 
and makes arrangements as to the terms of the loan, i. e., whether the 
Fifth National is to put the money out at a definite rate of interest, in 
which case the risk of exchange falls upon the English bank: or whether 
it shall charge the firm to which the money is loaned a small commis- 
sion, the borrowing firm, instead of the English bank, in this case 
assuming the risk of exchange. The amount of the commission or fee 
which the Fifth National is to receive is also agreed upon. The Fifth 
National Bank in either case finds a borrower in the market, possibly 
some investment house, or industrial or commercial firm, which de- 
posits collateral security for the loan just as it would for any other 
kind of bank loan. 

Currency or Dollar Loan. Let us say that the arrangements are that 
Barclays will charge a fixed rate of interest, say 4 per cent, and that 
it will assume the risk of exchange. This form of loan is commonly 
known as a “currency ” or “dollar” loan. The Fifth National Bank, 
following instructions, draws a draft or drafts on Barclays, running 
for 90 days and totalling £100,000, and sells the same in the open 
market to an exchange dealer, say the United Trust Company, at the 
going or current rate of exchange on that day for go day bills. If the 
rate is 4.83, the Fifth National Bank receives $483,000 (4.83 X 100,000). 
Suppose that it loans this amount to Jones and Smith, who have the 
use of the funds for the next ninety days at 4 per cent interest. Note 
that dollars are turned over to the borrowing firm. The United Trust 
Company, to which the draft is sold, immediately sends it to its corre- 
spondent in London, say Lloyds Bank, which presents it to Barclays 
for acceptance. After acceptance, Lloyds either has the draft dis- 
counted in the open market or holds it until maturity, depending upon 
the instructions that it has received from the United Trust Company. 
At the end of 90 days, if the loan is not to be renewed, Jones and 
Smith, in accordance with their agreement, pay the Fifth National 


TYPES OF FOREIGN BILLS OF EXCHANGE 203 


Bank $483,000 plus interest at 4 per cent for go days, or a total 
$487,830. Note that a predetermined number of dollars (principal plus 
interest) is paid back by the borrowing firm. It is because of this fact 
that this type of transaction is called a “dollar” or “currency” loan. 
The Fifth National Bank thereupon takes immediate action to cover 
the £100,000 draft falling due in London either by forwarding a de- 
mand draft against its own account with Barclays, or by going into 
the market and buying a demand draft from some other exchange 
dealer. Suppose that it does the latter. The amount of the draft 
would be for £100,000 plus the profit that belongs to Barclays after 
the Fifth National Bank has deducted its charges for acting as an 
intermediary. When the draft reaches Barclays it is immediately 
cashed at the bank upon which it was drawn, in order that the money 
may be on hand to meet the go day draft when presented at maturity. 
The profit that Barclays makes on the deal depends entirely on the 
New York rate of exchange for demand drafts existing on the day 
that the Fifth National Bank goes into the market and buys cover for 
the maturing go day bill. The English lending bank will usually enter 
into a dollar loan when the lookout in the exchange field appears to 
be for a falling sterling rate, because it assumes the risk of exchange 
and is therefore hoping to have cover purchased at a lower figure than 
is prevailing at the time when the loanis made. When dollar loans ap- 
pear in large amounts, comment on the street is that the market may 
expect to experience lower exchange rates in the near future. Suppose 
that the rate for demand bills does fall from 4.87, which prevailed at 
the time the loan was made, to 4.85 at the time when cover is pur- 
chased by the Fifth National Bank. The full face value of the sum 
returned by the borrowing firm, $487,830 (not deducting the commis- 
sion charges of the New York bank), converted into sterling at the 
demand rate of 4.85, will purchase £100,583 16s 2d of sterling ex- 
change (487,830 + 4.85), a gain of £583 16s 2d on the transaction. 
Figured on a percentage basis this amounts to a return of over 2.3 
per cent. If the demand rate drops lower, the return will be larger. 
If the demand rate remains high, say at 4.86, the Fifth National Bank 
will be able to purchase only £100,376 10s tod, representing a total 
gain of £376 10s 1od, or a return of only about 1.7 per cent. The 
rate of return received by the lending bank seems to be very small 
and it would be small had Barclays actually put up any of its own 
funds, but, as has been seen, the bank advances only its credit, i, e., 


204. DOMESTIC AND FOREIGN EXCHANGE 


allows its name to be used. It has merely accepted the draft and 
agreed to pay it when it falls due. Who or what it is that actually 
furnishes the money with which the deal is financed will be discussed 
later.1 

Loans of this kind, so far as the American borrowing firm is con- 
cerned, are no different from any other loan that it might procure 
from its New York bank. In fact, in practically all cases the bor- 
rowing concern has no idea that it is not actually borrowing the 
funds from the American bank; it has no knowledge whatsoever that 
a London bank is the party primarily interested in the transaction. 

Sterling, Franc, Mark, etc., Loans. Taking up another angle of 
foreign loans negotiated by means of bankers’ long bills, suppose that 
Barclays advises the Fifth National Bank that it will accept a com- 
mission on a loan and that the borrowing American firm is to assume 
the risk of exchange. This is known as a “sterling” loan. If marks 
were to be loaned by a German bank under the same conditions, it 
would be a “mark” loan, or if francs by a French bank, it would be a 
“franc” loan. In this case, the borrower knows that the loan is being 
engineered at the request of the foreign bank, because, when getting 
the loan, the borrower agrees to pay the principal plus the usual com- 
mission by furnishing the New York bank with demand exchange or 
with sufficient funds to purchase an amount of demand exchange 
equal to that which forms the basis of the loan. 

The English bank usually charges the small commission of 3/8 of 
one per cent for its acceptance of a go day draft. This amounts to 1/8 
of one per cent per month, or 1 1/2 per cent per year. The commission 
may seem to represent a small return to the lending or drawee bank, 
but again it must be remembered that the London bank does not ad- 
vance its own funds; it simply loans its credit or its name by accepting 
the draft, and the American borrowing firm, through the New York 
bank, puts it in funds with which to meet the draft when it matures. 
The London bank is liable for the full face value of the loan if any- 
thing goes wrong, but such possibilities are so slight as to be practically 
negligible.” 

In tracing the various details of a “sterling” loan, suppose the data 
to be the same as those given in the case of the dollar or currency loan 


tASt Dn OE 7. 

2 By many it is felt that the commission charged by the accepting bank is not commen- 
surate “with the risk involved should a monetary crisis ensue between the date of drawing 
and maturity of the bills.” Spalding, of. cit., p. 74. 


TYPES OF FOREIGN BILLS OF EXCHANGE 205 


above described. Barclays advises the Fifth National Bank to find 
a borrower for a sterling loan of £100,000. The terms are arranged by 
cable. A party willing to take such a loan, Jones and Smith, is found 
in New York. The commission is to be 3/8 of one per cent and the 
borrower is to bear the risk of exchange. The Fifth National Bank 
draws a 9o day draft for £100,000 on Barclays and turns it over, against 
a deposit of collateral security, to Jones and Smith. Note that a 
sterling draft is handed to the borrower. It is not unusual, however, 
for the New York bank, at the request of the borrowing firm, to sell 
the draft in the open market, because the bank is a keener bargainer 
and can secure a higher rate than can Jones and Smith. Say that 
the sterling draft is sold at the prevailing rate for go day bills, which 
happens to be 4.83, and that the United Trust Company buys it for 
$483,000. That amount of money is then turned over to Jones and 
Smith to be used by them for the next 90 days. The United Trust 
Company forwards the draft immediately to its correspondent in 
London, 1. e., Lloyds, which presents it to Barclays for acceptance. 
Again, Lloyds will discount the bill or hold it until maturity, following 
the instructions received from the United Trust Company. At the 
end of go days, Jones and Smith will furnish the Fifth National Bank 
with a sterling demand draft for £100,000 plus the 3/8 per cent com- 
mission, or will pay it a sum of American money that will purchase 
such a draft in the open market. It is because the borrowing firm has 
to purchase a sterling draft or has to pay the New York bank a sum 
of money, not determinable beforehand, with which to purchase such 
a draft, that this type of loan receives its name. Suppose that at the 
end of the go days the demand rate on London is 4.85. The principal 
of the loan is £100,000, the 3/8 per cent commission amounts to £375. 
How much money will Jones and Smith have to pay for a demand 
draft for £100,375 at the rate of 4.85? Multiplying the former by 
the latter, we get $486,818.75, an increase of $3,818.75 over the sum 
which Jones and Smith had received go days earlier from the sale of the 
sterling draft. This would be at the rate of approximately 3.1 per cent 
per year. If the demand rate for sterling were 4.86, the draft would 
cost $487,822.50, an increase of $4,822.50 over the sum which Jones 
and Smith had borrowed, or at a cost of 3.9 per cent per year. If the 
demand rate should fall low enough, the borrower might be able to 
get the loan for an extremely small interest rate or possibly for nothing 
at all. But no matter what the rate is, the London bank receives its 


206 - DOMESTIC AND FOREIGN EXCHANGE 


commission of 3/8 per cent and pays the New York bank its fee for 
acting as the intermediary. 

When Jones and Smith repay the loan, either in cash or by means 
of a sterling draft, the Fifth National forwards the sum to Barclays 
(minus its commission of possibly one-half of the 3/8 per cent charged 
by Barclays for the loan), thereby putting the accepting bank in funds 
with which to meet the £100,000 draft when presented by the holder at 
maturity. The transaction has been purely one of credit, no funds hay- 
ing been advanced either by Barclays or by the Fifth National Bank. 


“Because of the speculative element which attaches to loans of foreign 
money in this market, they are a favorite form of operation with many 
houses. Take for instance the case of a borrower of money who figures 
out that the exchange market is bound to decline within a few months. 
By getting some foreign banker to lend him money on the basis of his, 
the borrower, taking the risk of exchange, he can practically get himself 
short of the exchange market, and if he is right in his forecast he can get 
the use of the money for nothing, or even make a profit on the deal. Sim- 
ilarly with the banker. Frequently it happens that foreign money is pressed 
on the market here on the idea that exchange rates are about to go down 
and that the lender of the money, by assuming the risk of exchange himself, 
can make a big return on the money put out.” } 


Finance Bills. Another very important class of banker’s long bills 
is the so-called ‘‘finance bills.” Authorities differ as to what sort of 
bills this term actually applies. Escher alone holds that finance bills 
are those that arise through the initiative of a bank that desires to 
borrow from a foreign institution. In his “Foreign Exchange Ex- 
plained” ? he declares: 


“Make inquiry, even among those actively engaged in the exchange 
business, as to what the finance bill is and what it is used for, and the chances 
are that you will be amazed by the divergence of the expression you call 
forth. Almost generally you will find a tendency to confuse the finance 
bill with the loan bill * which has just been described. Now the finance 
bill is essentially different from the loan bill in that the loan bill is issued 
by bankers who want to lend out the money to third parties, on collateral, 
whereas the finance bill represents nothing more than the drawing of long 


1Escher, Franklin, ‘Foreign Exchange”, (Part II of “Banking Practice and Foreign 
Exchange” with Jefferson, H. M.), Alexander Hamilton Institute, New York, 1913, pp. 
321-322. 

2Pp. 102-103. 

3 He is referring to dollar and sterling loans. 


TYPES OF FOREIGN BILLS OF EXCHANGE 207 


drafts by one banker on another for the purpose of raising money to be 
used by either banker or both. In the case of a loan bill John Smith borrows 
from the First National Bank and puts up good and sufficient collateral 
for its repayment. In the case of a finance bill, the First National Bank 
draws a time draft on the Second National Bank, turns it into ready money, 
and uses the money (sometimes alone and sometimes, in connection with 
the drawee) for any purpose it sees fit. 

“There is, of course, no apparent difference in appearance between a 
loan bill and a finance bill. ... The circumstances which bring them 
into existence vary greatly, but the bills themselves, after they have been 
uttered, are all exactly alike.” 


Patterson states,! and Whitaker agrees with him,” that 
§ 


“Other authorities are inclined to include [as finance bills] all long bills 
originating between bankers, whether secured or not. The latter is 
perhaps the more general understanding of the term.” 


Although opposed by majority opinion, I cannot help but agree with 
Escher. In my opinion there are some very essential differences be- 
tween loan bills and the type that we shall henceforth call “finance 
bills.” In the case of the former, the initiative is taken by the foreign 
bank that wishes to place its funds or credit in the American market. 
In the case of finance bills, the initiative is taken by the American 
bank that is desirous of borrowing funds for its own personal use, or 
on joint account for the profit of itself and the foreign accepting bank. 
With loan bills, the American bank receives only its commission as an 
intermediary; with finance bills it gets all the gain minus the small 
acceptance commission charged by the foreign bank, unless the deal 
is carried through on joint account, in which case the two banks 
divide the profits between themselves. With finance bills the risk of 
exchange is borne by the New York borrowing bank, or, if the deal 
is on joint account, the risk is borne by both banks; but with sterling 
or dollar loan bills the New York bank assumes none of the risk of 
exchange. With loan bills, the borrower is a third party; with finance 
bills the New York bank is the borrower. 

Suppose that the Fifth National Bank of New York sees an oppor- 
tunity of swinging some big stock and bond deal,—possibly under- 
writing some large corporation,—which it feels it can handle satisfac- 
torily in three or possibly in six months and “get out from under”’ 
within that time; or suppose that some large stockbroker in New York 


1“‘Domestic and Foreign Exchange,” p. 144. 2 “Foreign Exchange,” p. 380. 


208 DOMESTIC AND FOREIGN EXCHANGE 


desires to borrow so as to invest heavily in stock and bonds; or suppose 
any similar situation arises in which the New York bank needs money 
but does not care to invest its own deposits and capital in the transac- 
tion; or suppose that the bank itself is getting rather short of funds and 
needs to build up its cash temporarily but does not wish to go to some 
other New York bank for a loan: any of these or similar circumstances 
may cause the New York bank to take the initiative and cable its 
London correspondent, say Barclays, to the effect that it wishes to 
draw £100,000 worth of go day bills against the latter. Will Barclays 
accept? The reply comes back that the arrangement is satisfactory. 
The New York bank may or may not be requested to deposit collat- 
eral security with some local trust company. ‘The Fifth National 
Bank naturally will not consider entering into such a transaction un- 
less it feels that exchange rates at the time that the bills mature will be 
at lower levels. 

If the situation looks promising, the Fifth National Bank draws 
£100,000 in go day bills on Barclays and sells them to some local ex- 
change dealer, say the United Trust Company, at the going rate for 
long bills on that day. If the rate is 4.83, it receives $483,000, which 
it will use for the next 90 days. The United Trust Company forwards 
the bills to its correspondent in London, say Lloyds, which presents 
them to Barclays for acceptance. When accepted the bills are either 
discounted in the London market or held until maturity, as indicated 
by the instructions of the United Trust Company. Another method 
of handling the deal would be for the Fifth National Bank to send the 
go day bills to another of its correspondents in London, say the London 
Joint City and Midland Bank, which would present them for accept- 
ance to Barclays, and when accepted have them discounted immedi- 
ately in the open market, and the proceeds (£100,000 minus the dis- 
count) credited to the account of the Fifth National Bank with the’ 
London Joint City and Midland Bank. The Fifth National Bank, in 
the latter case, could then sell demand drafts against the account which 
it has thus built up, and receive cash in New York for such drafts. - 
The reason for following this latter method is that the New York bank 
is thereby able to take advantage of the position of the discount rate 
in the London market and the rate for demand drafts in the New York 
market. Unless these two conditions are satisfactory, it will follow 
the procedure first mentioned, i. e., sell £100,000 of go day bills in the 
New York market. 


TYPES OF FOREIGN BILLS OF EXCHANGE 209 


For the purpose of making our problem as concrete as possible, 
suppose that the Fifth National Bank loans the $483,000 in the New 
York market at the short time loan rate of, say, 6 per cent. It re- 
ceives a total return at the end of the go days of $490,245. When it 
goes to buy sight exchange with which to cover the go day draft matur- 
ing in London, the sight rate on London is 4.85. To meet the £100,000 
draft plus Barclays’ acceptance commission of 3/8 per cent, it must 
purchase £100,375 at 4.85, which costs it $486,818.75. The profit 
of the Fifth National Bank on the $483,000 would amount to $3,426.25 
($490,245.00— $486,818.75) or a gain at the rate of 2.8 per cent per 
year. This 2.8 per cent return seems small, but it is placed in a 
different light when we remember that in the whole transaction the 
Fifth National Bank has not advanced one cent on its own funds. 

Let us take the case in which the Fifth National Bank sends its 90 
day drafts to London to be discounted immediately and against which 
it simultaneously draws drafts in order to take advantage of the dis- 
count rate in the London market and the demand rate for sterling in 
New York. The Fifth National Bank draws a draft on Barclays for 
£100,000 and sends it to the London Joint City and Midland Bank 
with instructions to present it to Barclays for acceptance, after which 
to discount it in the open market and credit the proceeds to its (the 
Fifth National Bank’s) account with the London Joint City and Mid- 
land Bank. Let us say that on the basis of the rate of discount in 
London, the stamp tax which long bills must pay in England, and the 
commission of the accepting bank (Barclays), the Fifth National 
Bank is able to get its funds in London at the cost of $.04875 per pound 
sterling. If the market rate for demand sterling is $4.8825, it sells 
£100,000 worth of demand drafts on its account with the London 
Joint City and Midland Bank and receives in return $488,250. It is 
able to sell for the full face value of the £100,000 because it has extra 
funds on deposit with the latter correspondent. It may then loan 
the $488,250 in the New York market at the current rate, say 6 per 
cent, and receive therefor $7,323.75. Suppose that, three months 
later, the demand rate for sterling, at which the Fifth National Bank 
has to purchase cover to forward to Barclays, is at 4.85. It will have 
to expend $485,000 for demand drafts to mail to Barclays so that the 
latter may meet the go day finance bills at maturity. The profits of 
the Fifth Nationai Bank are figured as follows: 


1 Cf. Margraff, op, cit. pp. 38-39. 


210 DOMESTIC AND FOREIGN EXCHANGE 


Received for £100,000 demand drafts @ $4.8825.... .$488,250.00 


Paid for £100,000 demand drafts as cover @ 4.85... . 485,000.00 
Grain, SUS ee awe ae 3,250.00 
Interest on $488,250 for 90 days at 6 per cent....... 7,333 095 
Total (Game cee ertenes 10;753075 

Cost of discounting, commission, stamps, etc., on 
£100,000 go day drafts @ $.04875 per £........ 4,875.00 
Net: Gait. Get wre ee eee $5,878.75 


A profit of $5,878.75 on $488,250 for a period of 90 days amounts to a 
gain of approximately 4.8 per cent per year. Out of this gain has to 
come the cost to the Fifth National Bank of the extra funds which it 
had to draw on in its account with the London Joint City and Mid- 
land Bank, the possession of which enabled it to draw demand drafts 
for the entire amount of the £100,000. 

Margraff * gives another example of the advantageous employment 
of finance bills by the American banker. The banker may have a 
large amount of money invested in certain securities which have tem- 
porarily depreciated in value just at the moment when there is a de- 
mand for money in the local market at: very favorable rates. The 
banker may either sell the securities at the depreciated quotation 
and take his losses, or he may hold them and not make the requested 
loans to his customers, or he may resort to the issuance of finance bills. 
Let us say that he puts up the securities as collateral for an issue of 
finance bills, and loans the money thus secured in the open market. 
If the finance bills cost him about three and a half per cent per year, 
and if the securities are yielding him an interest of three per cent, he 
has a net cost on the finance bills of about one-half per cent per year, 
but at the same time he has the return on the money received from 
the sale of the finance bills, which money he is able to loan in the open, 
market. By subsequent renewals of the finance bills, “the securities 
can be carried in this manner until the value of the same has re- 
covered by appreciation in price, and such holding would be advisable, 
provided: the securities were ‘gilt-edge,’ and there is every reason to 
believe that the shrinkage in value is only temporary.” ” 

Another method of using finance bills occurs in connection with 
the investment of the funds obtained therefrom in issues of corpora- 
tion securities either by the American bank or by it on joint account 


lop. cit. pp. 40-41. 2 Ibid, p. 41. 


TYPES OF FOREIGN BILLS OF EXCHANGE 211 


with the foreign accepting bank. If the American bank wishes to “go 
it alone,” it gets the permission of the London bank to draw the re- 
quired amount of go day finance bills, sells them in the market, 
and invests the returns in the selected securities. During the go days 
that the bills have to run, the bank will hope to unload the securities 
on the market at a price high enough to yield a profit over the cost of 
the demand bills which it must buy to meet the maturing finance bills, 
the commission of the accepting bank, and any other expense that it 
may have incurred. Very often such deals are arranged and carried 
through on joint account. The New York bank may be asked to 
join a syndicate of banking houses interested in floating some large 
investment proposition. It may not desire to invest its own funds, 
but invites the codperation of its London correspondent, which, be- 
cause of past profitable experiences, agrees to such an arrangement. 
The finance bills are drawn and sold, and the money is invested in the 
corporation issues. As the days pass the securities are unloaded onto 
the public, and at the end of the 90 days the New York bank goes into 
the market and purchases demand exchange to cover the maturing . 
finance bills. The rate at which the finance bills are sold, the prices at 
which the stocks and bonds are disposed of, and the rate at which the 
New York bank has to purchase demand’ sterling, determine the 
profit on the transaction, which profit will be shared between the two 
banks as stipulated in the agreement. An instance of the issuance 
of finance bills to take care of the needs of the security market occurred 
in October, 1912, when, owing to the interna tional uncertainties caused 
by the Balkan War, a mass of American securities were thrown onto 
Wall Street by Europeans. The New York banks immediately issued 
large amounts of finance bills in order to satisfy the demands of the 
brokers for funds with which to absorb those securities. 

It is not unusual for an American bank, when it is buying cover for 
its own maturing finance bills, to purchase finance bills that have just 
been issued by another bank in the same city, provided the rate is 
satisfactory. They are then sent abroad, accepted, discounted im- 
mediately, and the sum realized added to the foreign account of the 
American bank. Its foreign correspondent then has the funds on 
hand out of which the maturing finance bills are paid. 

In the case of loan bills and finance bills it is possible and frequently 
necessary for the issuing bank to ask for a renewal for another period 
of go days. The bond transactions described above may not have 


212 DOMESTIC AND FOREIGN EXCHANGE 


been pushed to completion, the borrowing American firm may wish 
to have the money for a little longer time, the American bank may 
feel that the rate for demand drafts has not declined sufficiently to 
make the transaction a profitable one and that there is a possibility of 
the rate going lower, or there may be some other contingency that 
may have to be met. Finance bills may be renewed by issuing a new 
lot at the then prevailing rate for go day bills and selling them in the 
market, the proceeds being used to purchase demand or cable ex- 
change to meet the earlier issues as they mature; or they may be 
exchanged directly, “that is to say, they are swapped for demand or 
cable exchange. The swapping operations are tantamount to the dis- 
count of the long bills in London and are arranged on the basis of the 
prevailing rates for long bills and demand or cable exchange. The 
amounts swapped are in each case equal, the holder of the long bill 
paying the holder of the demand or cable exchange the difference 
between the two prices, which represents the London interest and 
bill stamp converted into New York funds. If a £10,000 go day sight 
bill is exchanged for the same amount of demand exchange on the 
basis of $4.8090 for the long bill and $4.87 for the demand draft, the 
owner of the long bill pays the owner of the demand draft the differ- 
ence between the two rates for every £1 exchanged, or $610 on the 
entire swap.” ! If the American bank does not want to swap 9o day 
bills for demand or cable exchange, but prefers to issue a new lot of 
finance bills and sell them in the New York market, it may find that 
the exchange rates have fallen, precisely as it had surmised would be 
the case, and that, if it issues only the same amount as before, the sum 
received from the sale will not be sufficient to cover the face value of 
the maturing bills. Suppose that it had originally issued £100,000 
worth of finance bills at 4.85, receiving therefor $485,000, but that 
when the second lot is to be put on the market the rate has fallen to 
4.82. If the bank issues only £100,000 worth of finance bills, it will 
receive $482,000, or $3,000 less than for the first issue. Under such 
circumstances, it will probably get the permission of its London corre- 
spondent to issue an additional amount to make up the difference, or a 
total of approximately £100,622. The same procedure may also be 
followed in renewing either sterling or currency loans. 

In floating either loan or finance bills the American bank or the 
American borrowing firm is really speculating on the probable course 

1 York, T., “Foreign Exchange,” p. 152. 


TYPES OF FOREIGN BILLS OF EXCHANGE 213 


of the exchanges. As in the case of stock and bond deals, when a 
dealer sells short of the market, i. e., sells securities that he does not 
have on hand but hopes to obtain later at lower prices than those at 
which sold, so the American bank or borrowing firm that has to pur- 
chase demand exchange with which to cover the maturing long bills 
hopes that exchange rates will drop to lower levels. Thus it is that 
finance bills and currency loans usually come onto the market during 
the summer months when the prospects for large crops and conse- 
quently large exports, with accompanying lower exchange rates, ap- 
pear to be inevitable.! Prophets are not infallible, however, and it is 
not unusual for the exchange dealers to be deceived in their forecasts. 
Escher in his “Elements of Foreign Exchange” ” states that in 1909 
“TImpelled thereto by the brilliant crop prospects of early summer, 
foreign exchange houses in New York drew and sold finance bills in 
enormous volume. The corn crop was to run over three billion bushels, 
affording an unprecedented exportable surplus—wheat and cotton 
were both to show record-breaking yields. But instead of these 
promises being fulfilled, wheat and corn showed only average yields, 
while the cotton crop turned out decidedly short. The expected flood 
of exchange never materialized. On the contrary, rise in money rates 
abroad caused such a paying off of foreign bills that foreign exchange 
rates rose to the gold export point and ‘covering’ operations were 
conducted with extreme difficulty. In the foreign exchange market 
the autumn of 1909 will long be remembered as a time when the finance 
bill sellers had administered to them a lesson which they will be a good 
while in forgetting.” 

In order to guard against these unexpected developments in the 
foreign exchange field it is customary for the party that has to pur- 
chase cover to engage in “forward exchange operations,” 1. e., to 
“hedge” by buying what is known as a “future.” This is done by 
going to an exchange dealer and obtaining a contract from him to the 
effect that he will deliver the required amount of demand exchange 
at the designated date and at the rate contracted for. The dealer 
looks over the field, sizes up the possibilities of future developments, 


1“There is no doubt, of course, that many finance bills have been drawn in times past 
for less legitimate purposes [than those drawn in anticipation of produce shipments], to 
provide money that was going into factory building or other forms of fixed capital which 
ought to have been provided out of more permanent forms of security, such as bond issues 
or creations of shares or debenture stocks.’’ Withers, H., ‘‘War and Lombard Street,” 
p. 85. 

2Pp. 97-08. 


214 DOMESTIC AND FOREIGN EXCHANGE 


and estimates approximately what the demand rate will be go days 
hence. If the rate is satisfactory to the purchaser a contract for future 
delivery is signed. If when the go days have passed the rate in the 
market is higher than the rate contracted for, the purchaser gains and 
the dealer loses, but if the market rate happens to be lower than the 
rate contracted for, the purchaser loses and the dealer gains. In either 
case, however, the purchaser is able to minimize his probable losses 
by means of the “future” contract.' 

With the establishment of branches of foreign banks (including 
American banks) in London, an interesting development has taken 
place through the growth of what is technically “one name” paper, but 
what is familiarly known among exchange dealers as “house paper” or 
“pig on pork.” ‘This practice involves the drawing of loan or finance 
bills by a banking institution on its branch or on a financial institution 
which it controls. ‘The drawer and acceptor being virtually identical 
concerns, such bills represent but a single financial responsibility. The 
two-name class includes bills the drawers and acceptors of which are 
strictly separate and mutually independent establishments; they repre- 
sent a twofold security. On this account prime two-name bills always 
command a lower rate in the London market and a higher price in the 
New York market than the best one-name bills.”’ , The latter bills are 
issued, however, because the loss that is suffered by the banks by 
reason of the lower price “is more than compensated for by the sav- 
ing in acceptance commission they would otherwise be obliged to pay. — 

“Tssuers of one-name bills frequently put them out merely for the 
sake of the acceptance commission they thereby obtain. In lieu of 
selling the bills themselves, they turn them over to others who lack the 
requisite facilities for drawing on London, and receive the customary 
fee in return. Those accommodated in this way are generally large 
stock brokerage houses or money brokers. They dispose of the drafts 
in New York, andeither relend or utilize the proceeds in their own busi- 
ness. They procure the bills only upon giving satisfactory guarantee 
of furnishing the issuing banks with the exchange the latter will be 
obliged to remit to London as cover for the bills. This guarantee con- 
sists: (1) of immediately placing in the hands of the banks contracts of 
other prime institutions promising delivery of demand or cable ex- 
change when the long bills fall due; and (2) of engaging to supply the 


1 See pp. 497—502 for a more detailed discussion of ‘‘futures,” ‘‘ hedging,” and ‘‘ forward 
contracts.” 


TYPES OF FOREIGN BILLS OF EXCHANGE 215 


banks with the funds they will be required to pay on the future con- 
tracts, and to that end pledging with them stocks and bonds as 
collateral security.” ! 

Loan bills and finance bills have for many years past played an 
extremely important part in the foreign exchange market. Before 
the World War it was customary for from $300,000,000 to $500,000,000 
to be outstanding in the spring and early summer months when ex- 
change rates were usually high with the possibility of a decline in the 
fall as the crops began to move toward European countries. Bankers, 
brokers, and large industrial concerns have made wide use of them as 
a method of obtaining money at low rates, in many cases as low as 
1 to 14 per cent per year. London bankers, likewise, have been will- 
ing to act as acceptors and to receive their commission or their profits 
on joint accounts. They have also looked upon them favorably as a 
means of making loans to parties in other countries without as a rule 
entailing the exportation of gold.2,» Whenever exchange rates show 
a tendency to rise to higher levels, the banker immediately appre- 
ciates the opportunity of speculating on a possible decline, or it 
may be that he wants to build up his accounts abroad so that he may 
sell demand exchange against them and profit through the prevailing 
high exchange rates, or it may be that he has certain foreign obligations 
to meet and objects to paying such high exchange rates. Under these 
circumstances he will issue finance bills or loan bills. As Clare says 
in speaking of the situation between England and France, “. . . the 
bidding need only be raised a centime or two to tap an almost in- 
exhaustible source of supply,—that of bankers’ drafts.” ? A rising 
exchange market will normally bring forth a large supply of bankers’ 
bills, which, because they increase the supply of exchange available, 
normally reduce the rates of exchange. - In this way the floating of 
finance and loan bills usually keeps exchange rates from going to a 
point where it is profitable to export gold, and therefore assists in 
protecting the gold supply of the drawing country.* But it sometimes 
happens that the issuance of these bills may be the indirect cause of 
gold being drained from the country that has been drawn upon. A 


1 York, op. cit., pp. 151-152. 

2 Finance and loan bills ‘‘afford the most powerful and cheapest means of raising money 
without the actual employment of gold.’’ Gonzales, V., op. cit. p. 42. 

3 “The A. B. C. of the Foreign Exchanges,” p. 29. 

4 “Finance bills of this kind, drawn in anticipation of shipments of produce, thus per- 
form a most useful office by checking fluctuations in exchange, and expensive and clumsy 


216 DOMESTIC AND FOREIGN EXCHANGE 


situation of this kind occurred in 1906 and 1907 between England, 
Germany, and France on the one hand and the United States on the 
other. Large amounts of corporation securities had been floated in 
the New York market in 1906, and in order to obtain the needed funds 
and also in order to take advantage of the high money rates existing 
here (with low discount rates abroad), enormous amounts of finance 
and loan bills were drawn on English, French, and German banking 
houses. The issuance of such large sums lowered the exchange rates, 
especially those on England, and started the flow of gold to this coun- 
try. The movement of gold was aided both in the spring and in the 
fall by the Secretary of the U. S. Treasury depositing government 
funds with the importing exchange dealers, thus making the funds 
immediately available and saving the importers the loss of interest on 
the gold while it was in transit.'_ The net imports amounted to $103,- 
000,000, which with the exception of the year 1898 were the greatest 
in the history of our country up to that date. The rates on England 
were further weakened by the large number of drafts drawn on London 
by insurance companies for the purpose of obtaining funds with which 
to pay the losses of the San Francisco earthquake and fire. The 
situation became rather critical for the foreign banks, especially for 
the Bank of England, the Bank of France, and the Reichsbank of 
Germany. The London money market was badly strained, and it 
appeared necessary, as an English writer of the time stated, “to re- 
strict the creation of American credits on this [English] side of the 
ocean. For there is no doubt that the stringency in the money market 
would never have been so acute if Europe had not given excessive 
credits to America, who not only placed large amounts of finance 
bills in London, Paris and Berlin, etc., but began already, in the second 
half of the year, to place its railway debentures and railway ‘notes’ 
on the principal European money markets. All of the operations had 
to be liquidated by London, which was made responsible for the strin- 
gency that took place.” Another writer of the time also declared that 
“The London banks, by their treatment of New York finance bills, 
will decide whether the wild inflation of credit in the United States is 
to go on for another year or to be checked. So long as they accept and 


shipments of gold from one side of the ocean to another. If they were abolished, the ex- 
changes would tend to swing violently from one gold point to another, according as the 
movement of produce or the payment of other seasonal debts shifted the balance of claims 
from one country to another.” Withers, H., ‘War and Lombard Street,” pp. 84-85. 

1 Governmental aid ceased on October 23, 1906. 

2 Rozenraad, C., Journal of the Institute of Bankers, vol. 28, p. 206, April, 1907. 


TYPES OF FOREIGN BILLS OF EXCHANGE 217 


discount such bills, so long will the New York banks be able to buy 
gold in London, and the moment it is bought four more dollars may be 
lent against every dollar of it.” ! The Bank of England and the Reichs- 
bank of Germany were forced to raise their discount rates, which made 
money dearer in those countries and thus made it unprofitable for 
American bankers to issue new bills or to renew the old ones at matu- 
rity. Banks in England, France, and Germany discriminated against 
the American bills, so that by 1907 there were but $25,000,000 to 
$30,000,000 outstanding in England with much smaller amounts in 
Germany and France. Temporarily the flow of gold toward this 
country was checked, and matters became somewhat more normal. 
During 1907, however, our exports of crops to England were extremely 
heavy, and an oversupply of sterling exchange was again created. 
The usual amount of maturing finance bills was not present in the 
market. Normally the demand for exchange with which to retire 
finance and loan bills always stiffens exchange rates somewhat during 
the fall and winter months. But with only a small amount of such 
bills to retire, and with only a slight demand for exchange with which 
to cover, the exchange rates on England fell below our gold import 
point and gold flowed into the United States in huge sums. 

In the discussion of finance bills and loan bills we have continually 
stated that neither the American drawing bank nor the foreign accept- 
ing bank invests one penny of funds in the transaction. Just where, 
then, does the money come from? The answer is simple: It is the 
party that holds the bill until maturity that supplies the funds. As 
a rule, it is some discount house or bank in London. If the New York 
bank that purchases the long bill from the American issuing bank, 
gives instructions to its correspondent that the bill is to be presented 
for acceptance and held until maturity, the New York purchasing 
bank will under those circumstances furnish the funds with which the 
transaction is financed. On the other hand, if the New York bank 
instructs its London correspondent to have the bill discounted in Lon- 
don immediately upon acceptance, the money is advanced by the 
London bank or discount house that buys the bill, or, as we say, “the 
London discount market” advances the money. It is willing to do 
this, as has been noted earlier, because of the discount that is earned 
during the time that the bill is held. ? 

The discount market, especially that of London, is very sensitive 


1 Lawson, W. R., Bankers Magazine (England), vol. 82, p. 468, Oct., 1906. 


218 DOMESTIC AND FOREIGN EXCHANGE 


and carefully watches the amount of finance and loan bills that are 
issued bearing the acceptance of any one bank. As an English writer 
puts it, “ Merely as a means of raising the wind temporarily, it [the 
issuance of finance and loan bills] is an easy and pleasant device so 
long as it does not excite suspicion.” 1 The market has an uncanny 
way of keeping in touch with the amount of such bills that are offered 
for discount and, when once its suspicion has been aroused, it has no 
hesitancy in refusing to discount those bills that have been accepted 
by a London firm which it feels has “accepted” to too great an extent. 
Hints may be dropped that “so and so’s” bills are too numerous, or 
a more unfavorable rate of discount may be asked when they are 
offered for sale, or the market may refuse absolutely to discount them, 
or some other action may be taken to show that the market feels that 
the accepting firm has exceeded its limit. Very seldom has this prac- 
tice of issuing loan or finance bills been abused. Bankers and accept- 
ance houses appreciate the fact that they must not arouse the suspicion 
of the market if they desire to retain their credit standing with it. 


D. TRAVELER’S FUNDS 


American travelers, even in Canada, which has a monetary system 
practically the same as our own, find, as a rule, that American money 
cannot be used in foreign countries in making their purchases or in 
supplying their other needs. If they should take American money 
with them,” it would be necessary to have it exchanged at some money 


1 Lawson, op. cit., p. 460. 

2 It is surprising, however, to learn what large amounts of American money are actually 
in circulation in foreign countries under the disturbed conditions caused by the World War, 
due in part to the great depreciation in the purchasing power of foreign monies. The Fed- 
eral Reserve Bank of New York circularized banks and private banking houses in New 
York as to their shipments of United States paper money to and from foreign countries. 
The following tabulation covers the period from January 1 to April 30, 1921: 


Country Imports Exports 
Harope ce ons Kenly de Ss erate ee a ti elite Fats $35,121,251 $105,168 
Mexico-and South Americay ofa, 405+ + 2a 55s 1,773,062 1,355,000 
Cuba and Wést Indies i105 aa oe tales 12,257,770 9,684,500 
Catiada . vec) Banc ¢ alk peas co eae eis a hea 2,318,662 20,000 
Asia.gn 303s ator S hckuee co eens tens 687,230. Saeki eee 
ATrica,,. cicut.. oso 8504, bine Ce RAS eee 2c) 86,7007) seer eeeet 
Australis...) 505 so cee eats eco eer te keene 3,000 -» % pies cee 
Country not-reporteds 5.20. ken eeeneek eae 3,405,192 12,000 

Totals Fay) fc eee fon rat Baek $55,053,641 $11,176,668 


An additional $22,500,082 in United States paper money was forwarded by the Federal 
Reserve Bank of New York to Cuba for the account of New York City banks. The actual 
total amount of exports of paper money is greatly in excess of the sum stated because of 
remittances by individuals and because of the amounts taken out of the country by travelers. 


219 


TYPES OF FOREIGN BILLS OF EXCHANGE 


JOR 


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220 DOMESTIC AND FOREIGN EXCHANGE 


changer’s office or at some bank for the money of the country in 
which they were traveling. The rates of conversion in such cases in 
normal times are not usually satisfactory, so that the traveler takes 
the precaution of providing himself with the money of the country 
that he is to visit or with certain kinds of exchange documents that 
will furnish him with the needed funds when desired. He will usually 
resort either to traveler’s checks or to a traveler’s, or circular, letter 
of credit. We have already discussed the advantages and the methods 
of using traveler’s checks and traveler’s letters of credit in domestic 
travel. We may therefore confine our present discussion to their use 
in foreign travel. 

Traveler’s Checks. Before the great depreciation of the foreign 
exchanges occurred, the customary form of the traveler’s check was 
as shown in Fig. 60. It was issued in denominations of $10, $20, $50, 


WAY 


Hy 
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fa 
AS 
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ene 
Cal 


OTN OTN ER COUNTRIES coe 
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FIGURE 61 
New form of foreign traveler’s check 


$100, and $200, and sold at the rate of face value plus one-half of one 
per cent commission, the selling bank or agent retaining the commis- 
sion for its services as salesman. The express company or bank upon 
which the checks were issued received its return or profits through 
interest derived from the use of the funds until the checks were cashed. 
The old form of traveler’s check was convertible into foreign monies 
at fixed rates. As shown on the accompanying check, for instance, 
a $100 check could be cashed abroad for £20 8s 2d in Great Britain, 
512 francs and 50 centimes in France, Belgium, and Italy, 416 marks 
and 65 pfennigs in Germany, etc. If revenue stamps were required 
they had to be affixed by the holder when cashing the check, but other- 


TYPES OF FOREIGN BILLS OF EXCHANGE 22T 


wise the rates of conversion 
remained as designated on 
its face. This arrangement 
was extremely handy for 
the traveler for he knew ex- 
actly how much his checks 
were worth in the country 
in which he was traveling, 
provided he cashed them 
at any of the branch of- 
fices or agents of the issuing 
express company or bank. 
If cashed elsewhere he 
might have to pay an addi- 
tional, though slight, com- 
mission. 

With the World War, the 
vagaries of exchange rates 
upset calculations and poli- 
cies long followed, and it 
became necessary for banks 
and express companies to 
modify the form of their 
traveler’s check, and also 
the method of conversion. 
Fixed rates of conversion 
were no longer possible, so 
the simplest thing to do 
was to issue a traveler’s 
check payable at home in 
a fixed number of dollars, 
but payable abroad at the 
cashing banker’s buying 
rate of exchange for sight 
drafts on New York (Fig. 
61). This meant that the 
purchaser bought his trav- a 
eler’s check for $100plusa | — 5 - 
one-half or three-fourths =———~ | 





TREASURER. 


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BANMHMERS HERMES OM Sazaress. 2545 


TRAVELERS CHEQUE = “aman 


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FicuRE 62—American Express Company’s franc traveler’s check 


Masssiites 
MANILA © 


VALPARAISO 
THIS CHEQUE SHOWS YwE ExA 


PRINCIPAL OFFICES ABROAD 
WHICH WILL 8 PAID AY THE 


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222 DOMESTIC AND FOREIGN EXCHANGE 


per cent commission, and that when he cashed it in England he received 
in return $100 worth of English money calculated on the basis of the 
rate being paid that day for demand drafts on New York by the 
banker that cashed thecheck. If, for example, the English banker were 
buying demand drafts on New York at the rate of £1 for every $4.00 
of American money, the traveler would receive £25 in return for his 
$100 traveler’s check. As the exchange rates on the United States 
varied from day to day, he would receive varying amounts of foreign 
money for his traveler’s checks. Another form that has been adopted 
has been a traveler’s check payable in a fixed amount of money of 
one foreign country, but in all other countries made payable at the 
banker’s rates for demand drafts on New York. Thus in the case of 
the above “French franc traveler’s check” (Fig. 62), the American 
Express Company issues to the traveler a 200 franc check and charges 
him the franc rate for that day plus the usual commission. The trav- 
eler’s check can be cashed in France for 200 francs, but if the traveler 
goes to London, his franc check will be converted by the London 
banker into English money at the rate that the banker is that day pay- 
ing for demand franc drafts on Paris. In the case of a “sterling trav- 
eler’s check,” the check is drawn payable at a fixed amount of sterling, 
but if cashed in France or elsewhere it is converted at the banker’s buy- 
ing rate for demand drafts that day on London. If the traveler so de- 
sires, he may have a book of checks made up for him containing dollar, 
sterling, and franc traveler’s checks, and thus save himself the trouble 
of having them converted into the money of some other country. A 
third variation has been introduced by the Bankers Trust Company of 
New York, which, as noted earlier, issues the A. B. A. Traveler’s 
Checks. The form used by the latter bank and its agents provides 
that if a traveler is going to England he can buy a dollar traveler’s 
check, such as we have described in Chapter III. When he reaches 
England he can go to the London office of the Bankers Trust Com- 
pany and exchange his dollar checks for sterling checks at the banker’s 
buying rate for demand drafts on New York. If he takes a notion to 
go to France, he can visit the Paris office of the Bankers Trust Com- 
pany and exchange his sterling traveler’s checks for franc traveler’s 
checks at the banker’s buying rate for demand drafts on London, and 
so on in the various countries in which the Bankers Trust Company 
has made similar arrangements with bankers and correspondents. 
When any of the above described forms of checks are cashed in any 


TYPES OF FOREIGN BILLS OF EXCHANGE 223 


country in which conversion is necessary, the rate at which it is con- 
verted includes a slight commission for the bank that makes the 
conversion. 

If the traveler should lose his checks or they should be destroyed, 
he wires the nearest agent or the agent from whom they were pur- 
chased, and after he has put up an indemnity bond, the bank or express 
company will refund the face value of the lost or destroyed checks, or 
issue a new supply to him. 

Traveler’s or Circular Letter of Credit. When travelers plan to take 
with them more than $1,000 or its equivalent in foreign money they 
universally resort to a traveler’s, or circular, letter of credit. A 
traveler’s letter of credit is the oldest form of instrument used for the 
purpose of advancing funds to travelers and is still the one most widely 
used. The general form and methods of using such a document have 
been fully discussed in Chapter III. Only a few additional details, 
referring to its use in foreign travel, need be mentioned. 

The general form of a traveler’s letter of credit as used in foreign 
travel is practically the same as that for domestic purposes. It is 
customarily a four-page document, the first page bearing a printed 
letter addressed “To our Correspondents and other Bankers,” re- 
questing them to honor the drafts drawn against the letter by the 
accredited party. If the traveler is to remain in one country, it may 
be addressed only to a particular bank. The foreign circular letter is 
almost always drawn in terms of a foreign money, although it is some- 
times drawn in dollars. The drafts that are drawn under it are al- 
most universally ordered to be drawn against a designated foreign 
bank mentioned in the body of the letter, although the letter may 
require that they be drawn on the issuing American bank. The second 
page, sometimes both inside pages of the letter, contains columns in 
which are to be entered the dates on which drafts against the letter 
are paid, by whom, where, the amount in figures, and the amount in 
words. 

Let us say that Mr. Andrews goes to the First National Bank of 
San Francisco and applies for a £10,000 traveler’s letter of credit. He 
may obtain it in return for a cash payment, that is, he may buy it out- 
right by paying the value of £10,000 at the bank’s selling rate for 
demand sterling exchange on that day. He may or may not have to 
pay a commission, but if it is exacted by the issuing bank, it is usually 
about 1/8 to 1/2 of one per cent of the face value of the letter. If the 


224 DOMESTIC AND FOREIGN EXCHANGE 


banker’s sight rate on England is 4.85 on that day, and if no commission 
is charged, Andrews gets his circular letter for $48,500. The bank gets 
the use of that sum of money while the letter is being drawn against, 
the amount available for the bank’s use decreasing as drafts are cashed 
against the letter. If the traveler does not exhaust his letter, i. e., if 
he does not use all of the funds which it represents, the bank will buy 
the remainder from him upon his return, paying therefor the bank’s 
buying rate for demand sterling drafts. 

If the applicant is a depositor at the bank, enjoying a satisfactory 
credit standing, and also agreeing to keep on deposit an amount of 
money sufficient to protect the bank against loss, he may receive the 
letter of credit without making any payment at the time he gets it, 
or without depositing any security. He merely agrees to provide for 
the payment of the drafts together with the bank’s charges. In this 
case, when the drafts drawn against the letter finally reach the First 
National Bank, it debits his account with the face value of the drafts 
plus its charges. The bank watches the account of the traveler so as 
to be sure that enough remains in it to meet all possible payments 
that may have to be made as the letter is drawn against. The bank 
may also issue the circular letter to the applicant upon a deposit of 
sufficient collateral to protect the bank against loss. Under these 
two methods the bank receives no money in advance, and therefore 
cannot count on gaining any interest on the use of the funds involved 
as was the case with the first method. Also, when the letter of credit 
has been drawn on the issuing bank’s foreign account or deposit, say 
with Barclays of London, as the drafts drawn by the traveler are 
forwarded to Barclays and deducted by Barclays from the account 
of the issuing bank, the deposit of the latter with Barclays is to that 
extent reduced. It therefore loses interest on the amount involved 
from the time that its account is debited until it is reimbursed by 
debiting the account of the traveler or until it receives payment from 
him or from the guarantor of the letter of credit. As a consequence, 
if either of the last two methods is used, the bank will charge the 
traveler not only with the face value of the draft converted at the 
bank’s selling rate on that day for demand sterling drafts together 
with its commission of one per cent, but also with an additional charge 
for the interest lost. Some banks charge interest only for the time 
that elapses from the debiting of their foreign accounts to the time 
that the draft reaches them, while others charge, in addition, interest 


TYPES OF FOREIGN BILLS OF EXCHANGE 225 


for the length of time that it takes for the “cover” to be sent to re- 
-plenish their foreign accounts. It takes approximately seven days 
for mail to reach London from New York; some banks charge seven 
days’ interest; others, however, make a charge for fifteen days. 
Banks located in the western part of the United States frequently 
charge fifteen or thirty days’ interest. 

The majority of traveler’s letters are issued against a guarantee 
(Fig. 63) rather than against a deposit of collateral or for cash pay- 


GUARANTEE 
Letter of Credit No:: San Francisco, 


Whereas, The First National Bank of San Francisco has given to 


its Circular Letter of Credit No 


senetnecneeeimmeneteDnreenne hereby guarantee and agree to pay rma xe View he amounts drawn against said Letter of 
Credit, together with the usual charges. > gs 


say...7en_thousan§ pounds sterling oo. 


hereby authorize the said Bank to send the usual 


In case this credit be either lost 9 


Circular to its Correspondents, noti hem of the loss, and to take such precautions as it may deem 
advisable for the prevention of fraud agreeing to pay any expenses attending the same, and in case of 
the cashing of any drafts by any banker, under the usual precautions, and before the receipt of any circular, 


agree to indemnify the said Bank for any loss therefrom. 


Site 4........hereby authorize said Bank to charge to....my..........account any drafts, plus interest and 


commission, that may be drawn under this Credit, also any charges that may be incurred under same. 


FIGURE 63 


07—79——2-2-16—1M 





Foreign circular letter of credit agreement 


ment. The letters of guarantee will vary as between banks, but usually 
follow a general type, guaranteeing that the issuing bank will be paid 
“the amounts drawn against said Letter of Credit, together with the 
usual charges,” or that the traveler “hereby agrees and binds himself 
whenever notified of the payment of any or all drafts under said Credit, 
to provide for the payment of the same to you in Dollars, plus....... 
AMS MLUILELESU A Les oscsrent per cent per annum, at the current rate of Ex- 
change for your Sight Drafts on London, together with a commission 


226 DOMESTIC AND FOREIGN EXCHANGE 


Cie overs per cent on the amount of the drafts made by virtue of this 
credit.’ When collateral is deposited the agreement provides that 
the bank is authorized to sell at any time, with or without notice, at 
public or private sale, any securities that may be held by it as collateral 
for the circular letter which it has issued. 

When the clerk issues a circular letter he makes several copies. The 


Ae See pees Eels cet weet eee eco eseioaracaeee caeeraaaeeat meee 


Silt St joe 





fe co er: 
TheRirst National Bank of San Francisco Califomia 


= : Be ar 
hint Ince eee | 


Chose Mh nek : a : 4 
Ie ha ee De toe fe 
wattle Co yout: Ae. bo ae sehen x 
solhcdes seiprula vie efifrtis (etewwternb ibis MC. oe L pa oe alton Melee 


i 
4 
q 


the vide ritihe Whe in “Gs, 
at sgh wn ter Fhiibhy } dbbisenl Da lide, Coe Anylind, 

fer RY MELE PUB ere, ty Mygieg gle CUDA “of 
Ten thousani (519. chases i Yeerthng. 
phe do fe Soctcn ug? he ‘seresn fier oh Wes for Me veri Md tenon tong 
pailehirth by © ae we ROP? 

wie TUGUGE tb od. bfli BATU AL ALI Gal De MAPLE mith be fink 
ol Mik ti tute: oe sole fave Me Simok: See 

Ceurres haigesare of vortise ta be fund ty y le ected Aine 1p 
Shes sedi recll conliniue ex fe pew venlele eee ihe 
ee tehecdnedl tts elle the og final i Mga, ‘ 









gee POMLOD IE: 


Py : CL 
Aignabitie of Gonlloonent : 
CKS OG 2. Yor past, leh RE St: nad 





Be POE: ’ PPMP vehi renth 


tas: Pasko : : 





FIGURE 64 
First page foreign circular letter of credit 


original goes to the traveler, one copy to the files of the issuing bank, 
and, in case the letter is addressed only to one foreign bank, on which 
the traveler will always draw his drafts, a copy is sent toit. Whena 
business firm obtains a letter of credit for one of its traveling salesmen 
and guarantees the payment of drafts in the manner described above, 


TYPES OF FOREIGN BILLS OF EXCHANGE 227 


a copy may be given to it for its files. The copies are duplicates of 
only the first page of the letter. 

One type of traveler’s letters of credit bears the signature of the 
traveler on its face; the other type has the signature of the traveler 
appearing on the letter of indication which makes the first page of the 
small pamphlet containing a list of the bank’s correspondents.! This 







: * * > 2 ~ 
Saris Lau undee witlin Cock? 
AMOUNT 
& WORDS 


















ists besser sa qo beam e eas} oa 
os: peste oe > © s te 
: tae ei Gata KAAS Bek dt Bees a" 
: d eee 
: ee ae « ‘‘ 
§ » abs oe 
as eo} 8 fe * 
e 2 ere 
eA @je als i 
a bt EE a 
sis 2) 3 


FIGURE 65 
Second page foreign circular letter of credit 


list of correspondents contains not only the names and addresses 
of the actual correspondents of the issuing bank with which it has an 
account abroad, but also, in case the letter is directed only to one 
foreign bank, the names of the correspondents of that foreign bank. 

Let us say that Mr. Andrews gets his circular letter in sterling from 


1Cf. pp. 54-55. 


228 DOMESTIC AND FOREIGN EXCHANGE 


the First National Bank of San Francisco with the understanding that 
his account with that bank is to be debited with the face value of the 
drafts which he draws against his letter, converted at the bank’s sell- 
ing rate for sight sterling, plus commission and interest. The letter 
will be in the form on pp. 226-227 (Figs. 64-65). In this particular 
case the letter is issued in pounds sterling on the Bank of Montreal, Lon- 
don. The signature of the traveler appears on the face of the letter. 
The First National Bank clerk will also have Mr. Andrews signa signa- 
ture blank, which will be forwarded to the Bank of Montreal (Fig. 66). 


ADVICE OF LETTER OF CREDIT 
(10,000 eee No247 


The First National Bank of San Francisco 
To 
Bank of Montreal. 


> San Francisco_sanuary 6, 1921 
London, England. 


Gentlemen: 


We have issued our Travelers L fas No_34? January 6, 1921 





in favor of__Mre A. Be Andrews tae eye 
f j _. Ten, thansand pounds : 


authorizing. drafts on yourselves to the extent o q. 





This credit will bé in force tili_December 30, 1921 BAe you to accord due honor to 


any drafts drawn thereunder, charging same to our account, when presented in due form 


SPECIMEN SIGNATURE OF HOLDER Yours faithfully, 





FIGURE 66 
Advice of letter of credit 


When Mr. Andrews arrives in Paris and finds that he is in need of 
funds, he leafs through the list of correspondents and notes that the 
Crédit Lyonnais is the Paris correspondent of the First National Bank. 
He thereupon presents himself at the exchange window of that institu- 
tion and makes his wants known, handing the clerk the circular letter 
of credit. The clerk glances over it to see that the letter is still in 
force, i. e., that the expiry date has not passed, and also that the 
amount for which the letter was issued has not been exceeded. If in 
doubt concerning the form of the letter, he refers to his files and notes 
that the letter is on a form similar to the sample copies which have 
been received from the First National Bank when it established corre- 


TYPES OF FOREIGN BILLS OF EXCHANGE 229 


spondent relations. He may also wish to look up the signatures of 
the bank’s officials attached to the letter, so he again resorts to his 
files and consults the signature sheet which the First National Bank 
has also sent to all of its correspondents, which sheet bears the 
printed signatures of the officers who are authorized to sign any of the 
documents issued by that bank (Figs. 16-17). Some banks will have 
but one sheet of signatures, while the larger banks with many branches 
will have a small sized book of fifty or more pages of signatures of the 
officials who sign documents for the various branches. If everything 
is in order, the clerk asks Mr. Andrews how much money he desires. 
The clerk then makes out a draft for, let us say, £50, drawn on the 
Bank of Montreal, writes thereon “Drawn under Letter of Credit 
No. 347 issued by the First National Bank of San Francisco,” and 
passes the draft to Mr. Andrews to sign. The clerk then compares 
the signature on the draft with the one that appears on the circular 
letter of credit (or in the letter of indication if perchance it is that type 
of letter). If there appears to be no evidence of forgery, the clerk will 
pay Mr. Andrews as many francs as the £50 draft wil: buy at the pre- 
vailing rate for demand drafts on London, plus any commission that 
the correspondent may charge. Mr. Andrews will also have to 
pay any stamp duties or taxes that may be imposed. If the rate is 
25.22 francs for £1, Andrews receives 1,261 francs. The clerk enters 
the data of the transaction on the second page of the letter and returns 
it to Andrews. The Crédit Lyonnais forwards the draft to its London 
correspondent which presents it to the Bank of Montreal for payment. 
Inasmuch as the Crédit Lyonnais makes its profit on the rate which it 
charges Andrews, the Bank of Montreal will have to meet no other 
obligation than the payment of the £50 draft. The clerk of the Bank 
of Montreal will look up the signature blank of Mr. Andrews, and com- 
pare his signature on the draft with the one that appears on the signa- 
ture blank forwarded to it at the time the First National Bank of San 
Francisco issued the circular letter of credit. If everything is satis- 
factory the draft will be cashed and £50, plus any charges that may be 
made, will be deducted from the account of the First National Bank 
of San Francisco. The canceled draft or a statement to the same 
effect will be forwarded to the First National Bank, which in its turn 
will deduct a sum from Andrews’ account equal to £50 in American 
money converted at the bank’s selling rate for sterling sight drafts, 
plus commission and interest. 


230 DOMESTIC AND FOREIGN EXCHANGE 


If the letter has been issued in “dollars” and the drafts are to be 
drawn on the First National Bank of San Francisco, the procedure is 
the same so far as the general features of the transaction are concerned. 
The draft will be drawn in dollars on the First National Bank, the 
Crédit Lyonnais will give Mr. Andrews as many francsas his dollars will 
buy at the rate charged by the bank, and the draft will be forwarded 
to an American correspondent of the French bank, either in New York 
or in San Francisco. The latter will present the draft to the First 
National for payment, and when paid, will credit the account of the 
French bank with the dollars collected. Otherwise the procedure is 
the same as in the case of the sterling letter. Some firms in the United 
States find it profitable to provide their salesmen with traveler’s 
checks for small sums and with two letters of credit for large sums, 
one being drawn in sterling and the other in dollars, so that the sales- 
man may take advantage of the more favorable rate of exchange. 

“Fixed,” “advised,” or “restricted” letters of credit are frequently 
issued to clients who intend residing in a particular town or com- 
munity. They are addressed to a specified bank, to which the issuing 
bank also sends a special “advice” containing the signature of the 
client, the amount for which the letter has been issued, the date of 
expiry, and other data. The beneficiary is expected to cash his drafts 
drawn against the issuing bank or its designated correspondent only 
at the bank to which the letter is addressed. The procedure followed , 
in cashing drafts against the letter is the same as in the example first 
given. 

Some American banks have lately inaugurated the practice of fur- 
nishing books of bank drafts to their clients who have obtained a 
circular letter of credit from them. These bank drafts bear the num- 
ber and date of the circular letter of credit, thus avoiding one source 
of confusion, and enable the bank to segregate more easily from the 
day’s mail those drafts that have been issued under its circular letters. 

The smaller banks have no correspondents abroad against whom 
they may issue circular letters, so they arrange with exchange dealers 
in nearby financial centers either to have such letters issued on blanks 
bearing the local bank’s name or else the name of the exchange dealer. 
For instance, the State Bank of Evanston, Illinois will arrange with 
the Continental and Commercial Bank of Chicago to issue such letters 
on the Bank of Scotland, London, England. The Evanston bank will 
fill out the letter form, bearing its own name and address. Signatures 


TYPES OF FOREIGN BILLS OF EXCHANGE 231 


will be taken from the applicant and forwarded with the letter to 
Chicago. The Chicago bank will make the necessary entries in its 
books, send the signatures and required advices to the Bank of Scot- 
land, London, and after its own officials have signed the letter + will 
return it through the Evanston bank to the applicant. When the 
traveler goes abroad, draws and cashes his drafts, they are forwarded 
to the Bank of Scotland, which debits the account:of the Continental 
and Commercial Bank. They are then sent to the Chicago bank which 
will figure out its charges and deduct the same from the account of 
the Evanston bank, forwarding a statement thereof for the latter’s 
information. More often, however, exchange dealers do not allow a 
local correspondent to issue circular letters in this manner, but re- 
quire that the applicant obtain the letter direct from them in the same 
way as would be done by one of their own customers, the local corre- 
spondent merely acting as the agent of the issuing bank, forwarding 
the necessary signatures, the funds for cash payment, etc. 

Previous to the World War, all traveler’s letters were issued only 
against foreign banks, usually in terms of pounds sterling. Now, how- 
ever, an increasingly large number are being issued by American banks 
upon themselves, the drafts to be drawn in dollars as above described.’ 
In 1915 a few of the larger New York banks originated a new form of 
traveler’s letter which was a combination of the old-fashioned traveler’s 
check with fixed rates of conversion and the ordinary traveler’s letter 
of credit. The letter was issued in dollars, but when the traveler drew 
his drafts, he drew them in pounds, francs, marks, or in the money 
of any country in which he happened to be traveling. The drafts 
were then converted at the offices of the foreign correspondents des- 
ignated by the issuing bank, at fixed rates (like those on the old- 
fashioned traveler’s check *), which conversion rates were printed 
on the second page of the letter. Thus, if he drew a draft on the issuing 


1 This is necessary because the foreign correspondent does not have copies of the signa- 
tures of the officials of the Evanston bank. 

2“Mferchants are coming more and more to use American Express Traveler’s Checks 
and Circular Letters of Credit drawn in dollars for trading in Central and Eastern Europe, 
our European offices report. Both these forms of financial paper are desirable for this 
purpose because they are so readily accepted and so widely available, at the same time 
combining the advantage of being issued in a stable currency. 

“Traders who follow this practice are usually able to obtain considerable concessions 
over quoted prices by reason of being abe to pay cash. Another advantage is that these 
forms of paper are so fami iar throughout Europe that it is possible by approaching several 
banks to get at all times the best rate of exchange.” Foreign Trade Bulletin of the American 
Express Company, January-February, 1922. 

3 CE. p. 219. 


232 DOMESTIC AND FOREIGN EXCHANGE 


bank for $100 and presented it at the Paris correspondent’s office, he 
would receive $100 worth of francs at the fixed rate of conversion 
thereby avoiding the uncertainties arising from the fluctuating rates 
of exchange and also the exorbitant rates frequently charged by certain 
classes of foreign exchange dealers. Asa result of the extremely wide 
variations in the exchanges, which followed shortly after this new 
form was adopted, it had to be abandoned, but there is no good reason | 
why it should not again be used when conditions return to normal, 
embodying as it does all the advantages of the traveler’s check and 
the traveler’s letter of credit. 


E. MEANS BY WHICH CREDITORS SECURE PAYMENTS DUE THEM 


The remaining group of exchange documents comprises those that 
enable creditors to obtain payments due them for things sold, services 
rendered, money loaned, etc. 

Drafts Drawn without Commercial Letters of Credit, etc. An exporter 
will often use the trade acceptance as a means of obtaining payment 
for goods which have been sold to a foreign customer. This is the case, 
however, only where the two parties have had extensive dealings with 
each other and where the exporter has faith in the credit standing of 
the importer. When the goods are ready to be shipped and all the 
documents have been prepared, the exporter draws his draft directly 
on the importer, as per agreement, and sells the bill of exchange to 
his banker or hands it to him for collection. In either case, the im- 
porter accepts the draft when it is presented by the foreign correspond- 
ent of the American bank, and pays the draft at maturity or under 
rebate, depending upon whether the instructions are D/A or D/P 
respectively. As was noted in Chapter VII! it is not unusual for an 
exporter to sell goods to a foreign customer of excellent standing with 
the agreement that three months after the goods have been shipped, 
or possibly at the end of thirty days, a draft is to be drawn on the 
customer for the amount involved. The draft when drawn is sold to 
an exchange dealer or turned over to him for collection. Importers 
frequently run open accounts with exporting firms with the under- 
standing that a draft for the amount due shall be drawn on them 
every month.” Such an arrangement is customary between American 


LG Dors0- 
2Or the importer may remit monthly to the exporter. 


TYPES OF FOREIGN BILLS OF EXCHANGE 233 


firms and their foreign branches. Parties rendering professional ser- 
vices at the request of foreign firms or for individuals residing abroad 
usually draw drafts against their clients as per agreement and receive 
their fees or salaries in American money through the sale of their drafts 
to exchange dealers. American agents of foreign insurance companies, 
who desire to obtain funds from their home offices with which to make 
payments of losses, salaries, etc., do not wait for remittances to come 
from abroad, but draw drafts against their companies, sell them in 
the open market, and thus get the needed funds. In the late spring 
and early summer of 1906 foreign exchange rates were rather seriously 
weakened by the drawing of such drafts in large amounts in connection 
with payments made necessary because of the San Francisco earth- 
quake and fire of that year. 

Another very customary use of drafts in this connection is where 
they are drawn against securities which American stock and bond 
houses have sold to foreign clients. An order will come to a stock and 
bond house to buy too shares of Southern Pacific stock when the 
quotation in the market has reached a certain point. The stock is pur- 
chased by the bond house, a draft is drawn against the foreign customer 
for the amount of the sale plus the commission, and, with the bonds 
attached as collateral security, the draft is sold to an exchange dealer. 
Drafts of this sort find a ready market and always command high rates 
in the market for the reason that the credit of the drawer and of the 
drawee is further enhanced by the attached securities. 

Commercial Letters of Credit. Commercial letters of credit, some- 
times called “mercantile letters of credit,” and how they function in 
domestic trade, have been rather fully discussed in Chapter III. Men- 
tion was made of the fact that business men were as yet but slightly 
acquainted with their use in that connection, but that they were 
commonly employed in foreign trade in the financing of exports and 
imports. There are so many types of import and export credits that 
it is advisable to devote a separate chapter to a discussion of their 
characteristics and varied uses. 


CHAPTER IX 
IMPORT AND EXPORT CREDITS 


Exporters may agree to sell to foreigners, first, only for cash, i. e., 
cash to accompany the order, in which case the importer obtains the 
necessary amount of exchange on the exporter’s country, usually a 
banker’s sight draft, and sends it with his order. Or, second, the goods 
may be sent on open account, the agreement being that the foreigner 
is to remit for the goods when received, or that he is to pay for them 
at the end of a stated period, say within thirty or sixty days, or that 
the exporter is to draw a sight draft on him at the end of that time. ° 
In either of the last two cases, of course, the importer gets his docu- 
ments and his goods without having to pay for them and without hav- 
ing to accept any draft before obtaining possession. Or, third, the 
exporter may draw a sight draft on the importer at the time the goods 
are shipped and thus compel him to pay for the goods before he gets 
them. Or, fourth, he may draw a long time D/P bill and send it along 
with the documents, which accomplishes the same result, because the 
importer cannot get the goods until he pays the draft. Or, fifth, he 
may draw along time D/A bill on the importer, i. e., a trade accept- 
ance, which is seldom done in foreign trade unless the exporter has 
implicit faith in the credit of the importer, or unless the latter has 
arranged for an “ authority to purchase.” Or, sixth, the goods may 
be sent to the importer under the terms of a commercial letter of 
credit, which of all the practices followed is the most important and ° 
the one most commonly employed. 

Under a commercial letter of credit, the importer really substitutes 
the credit of a bank or accepting house for his own credit. We shall 
use the term “bank” in the subsequent discussion as including all 
classes of exchange dealers that are concerned with export or import 
credits. The exporter frequently does not know the standing of the 
importing firm, or if he does he may be unwilling to assume the 
risks involved in connection with shipping solely on that basis. Ameri- 
can bankers and exporters have been extremely slow in accumulating 
credit information concerning foreign firms. An exporter is not 


234 


IMPORT AND EXPORT CREDITS 235 


desirous of shipping goods to a foreign importing company unless he 
is assured of receiving payment. The foreign firm hesitates to send 
cash with its order because there have been many instances where ex- 
porters have failed in business before the goods have been shipped, 
thus causing a loss to the importers. Also, certain abuses of the trade 
which we do not need to consider have been fairly common among 
exporters when cash has been sent along with the order. Another 
reason why the importer does not wish to send cash with his order is 
that he does not care to stand the loss of interest on the money invested 
in the remittance. If, on the other hand, the goods are sent to him 
on any basis that approximates our domestic “C. O. D.,”’ he does not 
particularly enjoy the prospect of having to pay cash for his goods 
before having a chance to inspect them. The importer much prefers 
to obtain possession of his goods, to have about three months or longer 
in which to dispose of part or all of them, and thus to put himself in 
funds so that he may meet the payment when due. But as we have 
seen, the exporter prefers not to enter into any such arrangement un- 
less he is definitely assured as to the possibility of getting his money. 
The greatest advantage arising from the use of such import and export 
letters of credit and from the substitution of the bank’s credit for that 
of the importer or the exporter is that the bank or the discount market 
carries the burden of financing the transaction. If the drafts covering 
an export of goods are drawn on the importer, the amount of such 
bills that a bank will negotiate for the exporter is limited by the 
financial standing and credit of the latter. But if the drafts are drawn 
under a commercial letter of credit against a foreign bank, the amount 
that the exporter’s bank will then negotiate for him is practically un- 
limited. The exporter is able to get his money out of the transaction 
as soon as his shipment is ready and his documents have been sold to 
the bank. He can, therefore, finance many more export shipments 
than would be the case if he had to tie up his capital in them for an 
indefinite length of time. The importer also benefits from the use 
of a commercial letter of credit. He is not required to advance any 
of his own funds in order to import goods or to obtain possession 
thereof. He uses the credit of the accepting bank. He can therefore 
conduct a business of a much greater extent than if he had to depend 
solely upon his own resources. It is because of these reasons that the 
importing firm, having corresponded with the exporter as to the cost 
of the goods, the terms of sale, etc., and an agreement having been 


236 DOMESTIC AND FOREIGN EXCHANGE 


reached between the two contracting parties regarding all details of 
the proposed transaction, goes to its bank and asks for what, under 
the circumstances, is known as an “import letter of credit.” Ifa 
commercial letter of credit is requested by an exporter for the purpose 
of financing exports, it is known as an “export letter of credit.” ! 

Commercial letters of credit are usually for large amounts. Banks 
ordinarily refuse to issue them for less than $500, sometimes for less 
than $1,000, because of the bother involved in handling small sums. 
It must be remembered that the commercial letter of credit itself is 
not a bill of exchange, but merely a means through which or by means 
of which a bill of exchange is brought into existence. Such bills may 
be either clean or documentary, demand or time, D/A or D/P. 
Commercial letters of credit have been used extensively by American 
merchants only since 1914. 

Import Letters of Credit. In order to make our problems as simple 
_as possible, let us first consider the intricacies of a “dollar” import 
letter of credit, issued to the American Importing Company of New 
York City by the Guaranty Trust Company of New York, covering 
the importation of a shipment of silk from the Asaki Silk Company 
of Yokahama, Japan. The silks are valued by the exporter at 40,000 
yen. When asked by the American importer to quote prices, the Asaki 
Silk Company goes to its bank, the Sumitomo Bank Ltd., and ob- 
tains from it a contract in which the bank agrees to buy the exporter’s 
draft on an American bank covering the shipment at the rate of 2 yen 
per dollar. The exporter is able to obtain this satisfactory rate be- 
cause the draft will subsequently become a banker’s acceptance, which 
involves little or no risk for the Japanese bank that has agreed to buy 
the draft. The exporter obtains this “forward” quotation in order 
to avoid the possibility of a loss through fluctuations in the exchange 
rate which may take place between the time that it advises the im- 
porter as to the cost of the goods and the time that the draft is sold to 
the Japanese bank. In quoting prices to the American Importing Com- 
pany the exporter is thus able to advise that the silks will cost $20,000 
(40,000 yen + 2). It notifies the importer that shipment will be made 
only under a commercial letter of credit. All other matters concerning 
the shipment and the costs thereof having been definitely settled 
between the exporting and the importing firms, the American Import- 
ing Company goes to the Guaranty Trust Company of New York 

1Cf. pp. 260-268. 


» 
*) 
a 
S| 
4 
g 
% 
a 
I 
S| 
< 
i) 


TRANSFERRED FROM LETTER BY. 


. CREDIT PREPARED BY......DIV..... 


sHEAD, . 3. = 


. 
. 
. 
‘ 


APPLICATION CHECKED BY..... 





- CREDIT CHECKED BY. 


»+- +. CABLE CHECKED BY. 


IMPORT AND EXPORT CREDITS 237 


Guaranty Trust Company of New York 
APPLICATION FOR LETTER OF CREDIT 


New York, —__ Jan. & 1981, 


Guaranty Trust Company or New York 
ForEIGN DEPARTMENT 

‘Import 
New York City 


GENTLEMEN; 


Division 


Please issue an Irrevocable Letter of Credit by Soine 


For account of 
In. favor of Asaki Silk Company 


#20.000.00 valebleshy. diattsyat Sour44,Months sight 


MALOU te ceca 


against documents as follows: 
Bills of Lading reading Bills of Lading 
“Received for Shipment” or 
otherwise worded to same _ Invoice 
. effect are acceptable against 
this credit. Consular Invoice 


( 
other documents ’ 


covering Sat invoice value of C. I. F.,6-&F+F-O-B>2-+-S. Shipments, 


(croas out all but one) 
L, 
Yokohama. __t New York City 
March 31, 1921. 
Shippers 
(Shipper or Purchaser) 


to be shipped from 
Drafts to be negotiated on or before- 
Insurance to be effected by 
Partial shipments are to be permitted. 
Special Instructions 

The Letter of Credit is subject to your usual terms and ‘conditions, and in 
consideration of the issuance thereof we agree to reimburse you on.demand, and 
we hereby authorize you to charge our account with you with any and all 
amounts for which you are liable theredudes plus your commission and charges, 

Neither you nor your correspondents shall be responsible for the description, . 
quantity, quality or value of the merchandise shipped under this credit, nor for 
the correctness, genuineness or validity of the documents, nor for delay or devi 
ation from instructions in regard to shipment, nor for any other cause beyond 
your control. 

Very truly. yours, + 
The Guaranty Trust Company of New American /mporting Co. 

York does not assume responsibility for SELES UE nd Se aa 
any inaccuracy, interruption, or delay in 
the transmission or delivery of messages 
by cable. 


New York City 





FIGURE 67—Application for commercial letter of credit 


238 DOMESTIC AND FOREIGN EXCHANGE 


and asks for a commercial letter of credit, say for $20,000. It advises 
the bank as to the terms of the letter that is desired, the amount for 
which the drafts are to be drawn, by whom the insurance is to be 
effected, etc. If the bank is willing to issue the letter it may ask the 
importing firm to fill out an ‘Application for Commercial Credit” 
blank (Fig. 67) and a “Letter of Guarantee” (Fig. 68). 


New York, ——__—___————_I19__ 
To the 
GUARANTY TRUST COMPANY OF NEW YORK 
Gentlemen; 
Having received from you the Letter of Credit on ————————account of 


which a true copy is on the other side, eh hereby agree to is terms, and in 


consideration thereof ‘ agree with you to provide in New York, one day 


€ 
previous to the Maturity of the Bills drawn in virtue thereof, sufficient funds 
in cash, to meet the payment of the same with per cent 


commission, and fi undertake to insure at i expense, for your benefit, 


against risk of Fire or Sea, all property purchased or shipped pursuant to said 
Letter of Credit, in Companies satisfactory to you. 

a agree that the title to all property which shall be purchased or shipped 
under the said credit, the bills of lading thereof, the policies of insurance thereon 
and the whole of the proceeds thereof, shall be and remain in you until the pay- 
ment of the bills referred to and of all sums that may be due or that may become 
due on said bills or otherwise, and until the payment of any and all other in- 
debtedness and liability now existing or now or hereafter created or incurred by 
5 to you on any and all other transactions now or hereafter had with you 
with authority to take possession of the same and to dispose thereof at your dis- 
cretion for your reimbursement as aforesaid, at public or private sale, with- 
out demand or notice, and to charge all expenses including commission for 
sale and guarantee. 

Should the market value of said merchandise in New Vork, either before or 
after its arrival, fall so that the net proceeds thereof (all expenses, freight, duties, 
etc., being deducted) would be insufficient to cover your advances thereagainst 


with commission and interest, fe further agree to give you on demand any 


further security you may require, and in default thereof you shall be entitled to 
sell said merchandise forthwith, or to sell “to arrive,” irrespective of the matu- 


rity of the acceptances under this Credit, i being held responsible to you for 


myself 


ourselves to pay you in cash on demand. 


any deficit, which ie, bind and oblige 


If 


In case ou should hereafter desire to have this credit confirmed, altered or 


extended by cable (which will be at He expense and risk), a hereby agree to 


IMPORT AND EXPORT CREDITS 239 


hold you harmless and free from responsibility from errors in cabling, whether 
on the part of yourselves or your Agents, here or elsewhere, or on the part of the 
cable companies. 

This obligation is to continue in force, and to be applicable to all transactions, 
notwithstanding any change in the composition of the firm or firms, parties to 
this contract or in the user of this credit, whether such change shall arise from 
the accession of one or more new partners, or from the death or secession of 
any partner or partners. 

It is understood and agreed that if the documents representing the property 
for which the said Credit has been issued are surrendered under a trust receipt, 
collateral security satisfactory to the Trust Company, such as stocks, bonds, 
warehouse receipts or other security, shall be given to the Trust Company, to 
be held until the terms of the credit have been fully satisfied and subject in every 
respect to the conditions of this agreement. 

It is further understood and agreed in the event cf any suspension, or failure, 


or assignment for the benefit of creditors on ses pari, or of the nonpayment at 


maturity of any acceptance made by is of the nonfulfillment of any obliga- 
tion under said credit or under any other credit issued by the Guaranty Trust 
Company of New York on i account, or of any indebtedness or liability on 


my 
our 
soever shall thereupon, at your option then or thereafter exercised, without notice, 
mature and become due and payable. 

It is understood and agreed that you shall not be held responsible for the 
correctness or validity of the documents representing shipment or shipments, 
nor for the description, quantities, quality or value of the merchandise declared 
therein. 


part to you, all obligations, acceptances, indebtedness and liabilities what- 


(Signature) 
FIGURE 68 
Agreement signed by applicant for commercial letter of credit 


Or the bank may ask the importing firm to fill out a blank 
whichis both an application and a letter of guarantee. Most 
blanks are of the latter type. The application, usually printed, 
although sometimes typewritten, supplies data concerning the 
amount for which the letter is to be issued, the usance of the 
drafts, the party by whom they are to be drawn, the dura- 
tion of the letter, the date before which the drafts must be drawn 
and negotiated, by whom the insurance is to be effected, the date be- 
fore which shipments must be made, and various other details regard- 
ing the number and kind of documents that must be provided, to 
whom they are to be sent, how indorsed, etc. The “guarantee,” as 
will be noted from the above form, advises the bank that the annli- 


240 DOMESTIC AND FOREIGN EXCHANGE 


cant will provide it with funds with which to meet the drafts when 
they mature, that all expenses are to be paid by the applicant includ- 


Import Letter of Credit (Dollars) 


Credit No, —!54567_._ Guaranty Trust Company of New York 


$20 ,000—U S.C. Foreign Department 
1S A ala ane dle 


New York February 11, 1921 


MessrsiAsaki Silk Company, 
Yokohama, Japan 


Gentlemen; 


At the request and for the account of The American Importing Company, New York _ American Importing Company, New York 


we hereby authorize you to value on 
Guaranty Trust Company of New York, New York 
by your drafts at___Four (4) Months sight__for any sum or sums not exceeding a total of 


Twenty thousand dollars (820,000) ; 
accompanied ‘by commercial invoice, consular invoice, bills of lading _ Marine extermmanta, in- 


surance certificates 


representing ———tostrinsurance and freigh——<pzpment of Raw Silk from Yokohama, Japan, to 


New York- 


Insurande Marine eu insurance to be effected by the shippers 


Bills of lading for such shipments must be drawn to the order of Toe Guaranty Trust 
Company or New York, unless otherwise specified in this credit. 


A COPY OF THE CONSULAR INVOICE AND ONE BILL OF LADING MUST BE SENT BY THE BANK 
OR BANKER NEGOTIATING DRAFTS, DIRECT TO THE GUARANTY TRUST COMPANY OF NEW YORK, 
NEW _YORK. 


THE AMOUNT OF EACH DRAFT NEGOTIATED TOGETHER WITH THE DATE OF NEGOTIATION 
MUST BE ENDORSED HEREON. 


We hereby agree with bona fide holders that all drafts drawn by virtue of this Credit, 
and in accordance with the above stipulated terms, shall meet, with due honor upon presen- 
tation at. the Guaranty Trust Company of New York, New York, if drawn and negotiated on 
or before May 81; 1919 . 


Guaranty Trust Company of New York 
N. B.—All drafts drawn under this Credit must 
bear clause “drawn under G. T. Co. of 
N. Y. Letter of Credit No.184567_ 


dated New pir omaha EL BLS al 
to cover shipment of __Raw Silk __ trom 
Yokohoma tn New York 








FIGURE 69 
Dollar import letter of credit 


IMPORT AND EXPORT CREDITS 241 


ing the bank’s commission, that title to the goods is to rest in the 
bank until the applicant has met his obligations, that the bank may 
take steps at any time to protect itself against loss, etc. An interest- 
ing clause that should not be overlooked declares that if the merchan- 
dise should decline in value either before or after its arrival, thereby 
possibly causing the bank to suffer a loss, the applicant will either 
provide additional security as required or allow the bank immedi- 
ately to possess itself of the goods and sell the same and also that 
the applicant will reimburse the bank for any losses incurred by it. 
A copy of this document is given to the applicant for his 
files. 

After the applicant has filled out the above form or forms, the bank 
clerk takes a commercial letter of credit blank (Fig. 69) and fills in the 
spaces in accordance with the data supplied on the application. The 
importing firm may or may not be required to put up collateral se- 
curity. : 

The terms of the letter, the details of which vary from bank to 
bank, universally direct the exporter to draw a draft or drafts on the 
issuing bank covering the value of the goods which are to be for- 
warded. The amount of the credit, the date of its expiry, how the 
documents are to be prepared, how many and what kinds, possibly 
upon what steamer or steamship line the goods are to be sent, these 
and all other necessary directions are contained in the body of the 
letter of credit. In brief, it is a statement by the issuing bank that it 
will accept drafts drawn on it by the exporter and that it will meet 
them at maturity provided goods are sent and documents are drawn 
in accordance with the directions contained in the letter of credit. 
The letter of credit seldom alludes to the sales contract between buyer 
and seller because the issuing bank has no direct concern in the terms 
of such contract or in any controversy that may arise over the mer- 
chandise to beimported. ‘“ Moreover, the banker negotiating the drafts 
under the letter would look with disfavor upon the inclusion of com- 
mercial details which he is unable to verify. In fact, a credit burdened 
with such stipulations, would prove of little value, as foreign banks 
generally would refuse to negotiate the drafts. On the other hand, 
some banks feel obliged to protect the interests of their clients, and 
this explains the considerable number of institutions reporting that 


1Cf. Federal Reserve Bulletin, April, 1921, pp. 410-415, ‘Forms of Commercial Letters 
of Credit.” 


242 DOMESTIC AND FOREIGN EXCHANGE 


they do refer to the sales contract in their letters of credit. Such men- 
tion is made to a varying degree. In some cases the terms of the credit 
merely follow the stipulations of the contract in a general way. Other 
banks go to the extent of specifying the grade, quantity, and price of the 
merchandise.” Still others request “a declaration, furnished by 
the accredited party, that the goods were shipped in accordance with 
the terms of the contract between the buyer and seller.” * Where the 
letter of credit incorporates some or all of the terms of the contract 
of sale, such terms become part of the letter of credit and both the 
issuing bank and the exporter (seller) are bound by them. The issuing 
bank has the right to refuse to accept the draft as drawn by the ex- 
porter unless he has completely followed the terms of the letter of 
credit. If the terms of the sales contract are not included, the letter of 
credit and the sales contract are two separate and distinct documents, 
and have been so declared by various courts. In case there is any 
breach, dispute, or default of the sales contract, where it is a separate 
document, the aggrieved party has a right of action at law to recover 
damages, but such breach or default cannot in any way affect the 
contract between the bank and the seller, or between the bank and the 
buyer as contained in the letter of credit.* 

A commercial letter of credit is usually issued in duplicate, one copy 
for the files of the applicant, the other to be sent to the exporter. The 
issuing bank either keeps a carbon copy or makes a record of the trans- 
action for its files. ‘The importer at whose instance the credit is 
opened may choose to have the exporter notified by cable or mail. 
If by mail, the bank hands the letter to the importer, who forwards 
it to the beneficiary. If by cable, the bank usually communicates 
with its correspondent nearest the point of shipment.* When it is 
definitely known through which bank the exporter will negotiate his 
drafts, the letter is then sent to this institution.” ° The exporter is 
ordinarily free to sell his drafts to any bank willing to negotiate them, 
although under certain conditions he may be limited by being re- 
quired by the terms of the letter of credit to negotiate the drafts only 

1 Federal Reserve Bulletin, February, 1921, p. 166. 

2 Tbid. The Federal Reserve Bulletin of February, April, June and October, 1921, con- 
tains the results of a most excellent study of commercial letters of credit made by Mr. 
George W. Edwards of the Division of Analysis and Research of the Federal Reserve Board. 
A portion of the following discussion is based to some extent upon the data there presented. 

3 Cf. American Steel Company vs. Irving National Bank, 233 Fed. ar. 


4 Cable notifications are subsequently confirmed by mail. 
5 Federal Reserve Bulletin, February, 1921, p. 166. 


IMPORT AND EXPORT CREDITS 243 


at the bank so designated in that document. Exporters object to 
being restricted in this regard because it compels them to deal with a 
strange bank which as a rule will not give them so good a rate on their 
drafts as will the bank with which they have long been accustomed 
to carry on their financial relations. Sometimes copies of the letter 
of credit are sent to the exporter by separate steamers so as to lessen 
the possibility of delay in case one of the letters is lost in transit. 
“However, duplicate letters offer the opportunity of presenting drafts 
and letter to one bank and repeating the same operation with a second 
bank. To prevent a fraud of this nature, banks place negotiators on 
their guard by indicating clearly in the duplicate form that an original 
is in existence.” 4 

The Asaki Silk Company, upon receiving the letter of credit, pre- 
pares the shipment, procures the various sets of documents as re- 
quired by the terms of the letter of credit, draws a draft, one for each 
set of documents, a “first,” “second,” etc., and goes to the Sumitomo 
Bank Ltd. to sell its documentary bill of exchange. The draft will 
be drawn on the Guaranty Trust Company of New York, (not on the 
American Importing Company), for $20,000. Notation will be made 
on the draft that it is drawn under “Number 134567 letter of 
credit issued by the Guaranty Trust Company of New York.” If the 
letter of credit were to cover two or more shipments, the Sumitomo 
Bank Ltd., when it bought the bills of exchange, would indorse the 
amounts and the dates on the back of the letter of credit, so as to avoid 
the possibility of any fraud arising. The bank clerk looks over the 
documents to see that they are in order and in accordance with 
the terms of the letter of credit, and if everything is satisfactory 
the Asaki Silk Company will receive 40,000 yen for the docu- 
mentary bill of exchange as per the “forward” contract mentioned 
above. 

The Sumitomo Bank Ltd. then indorses the documents and forwards 
them to its correspondent in New York,’ which in this case happens 


1 Federal Reserve Bulletin, February, 1921, p. 167. 

2 “American banks issuing import letters of credit uniformly require that foreign banks 
indorse on the reverse side particulars of all drafts negotiated. This precaution is taken 
to prevent an unscrupulous foreign exporter from presenting his letter and shipping docu- 
ments simultaneously to several banks and thus overdrawing his credit.’ Federal Reserve 
Bulletin, February, 1921, p. 165. 

3It is customary for the foreign purchasing bank to forward the documents to the ac- 
cepting bank through a correspondent. But in case of banks located in China that are 
correspondents of the American accepting bank, it is customary to forward the documents 
direct to the accepting bank, which after accepting the draft will as a rule sell its own 


244 DOMESTIC AND FOREIGN EXCHANGE 


to be its New York branch, with instructions to present the draft to the 
Guaranty Trust Company for acceptance and then to discount it in 
the open market.!. Whether or not the letter of credit will accompany 
the draft that exhausts the credit will depend entirely upon the prac- 
tice of the beneficiary, the Asaki Silk Company. The general rule 
is that the letter of credit is not attached to the final draft, although 
the tendency at present seems to be to return the original credit.? 

When the documents have reached New York, the correspondent 
of the Sumitomo Bank, Ltd. presents the draft to the Guaranty Trust 
Company for acceptance. Under a commercial letter of credit the 
documents always go forward under “D/A” instructions, because 
of the unquestioned credit of the issuing bank upon which the draft 
is drawn. Therefore when the Guaranty Trust Company accepts the 
draft, it detaches the documents and returns the accepted draft to the 
presenting correspondent which, following instructions, has it dis- 
counted immediately in the open market at the prevailing rate for 
banker’s acceptances, and credits the sum obtained to the account 
of the Sumitomo Bank, Ltd. In this manner, the Japanese bank builds 
up its account in the United States against which it may sell exchange 
in the future. If the draft has been drawn in duplicate, the New York 
correspondent does not wait for the second set to appear before pre- 
senting the draft for acceptance. The first set to arrive and to be 
accepted nullifies all other sets.? The documents are usually sent by 
fast steamers, one set to a boat to guard against possibilities of loss, 
while the goods are forwarded by ordinary freighters; but it some- 
times happens that the goods arrive ahead of the documents. 

The Guaranty Trust Company, having the shipping documents in 
hand, notifies the importing firm to make arrangements for their re- 
lease. It may turn the documents over to the American Importing 
Company without taking any sort of security and without asking it 
to sign anything other than just a receipt. This is done only where 
the bank has implicit faith in the importer. It is more customary to 


acceptance in the open market just as though it were the acceptance of some other bank, 
although at times, however, it will hold its accepted draft until maturity. 

1 The instructions from the Japanese bank may, however, be to the effect that the draft 
is to be presented for acceptance and then held until maturity. 

2 Federal Reserve Bulletin, February, 1921, p. 165. 

3In Holland it is not legal for drafts to be presented for acceptance until the duplicate 
has arrived; the banker must have all sets of the documents in his possession before ac- 
cepting. 


IMPORT AND EXPORT CREDITS 245 


ask the importer for a trust receipt,’ the terms of which will vary 
somewhat depending upon just what the importer wishes todo. Many 
banks use the same printed form for all purposes, but usually different 
forms are used for different conditions. If the importer wishes to 
obtain the documents so that the goods may be warehoused upon 


TRUST RECEIPT 


(DOCUMENTS FOR WAREHOUSING) 


Rereived from Tur Guaranty Trust Co. or New York Bill of Lading per. 
dated for the following goods and merchandise, 


|. théir property, marked and numbered as follows: 


imported under the terms of Letter of Credit No.________________, issued by them for 


= account the said Bill of Lading to be used by = for the sole purpose of entering the 
ur z s- 


above described property at the United States Custom House at the Port of 
and of storing the same in the name, and as the property, of the 


said Tur Guaranty Trust Co. or New York, and subject only to their order, } — 
we 


_ hereby agreeing to so store the said property and to hand the storage receipt for the same to 
the said Tue Guaranty Trust Co. or New York, when obtained. 
=. { atso AGREE to fully insure said property against fire, the loss, if any, payable 
.to said Taz Guaranty Trust Co, or New York, and to hand to them the policies of insur- 
ance thereon. 
Dated ee SA ators Sell Se nb 


(Signed) 





FIGURE 70 
Trust receipt (documents for warehousing) 


arrival, the bank will take from him the above type of trust receipt 
(Fig. 70). 

1 The practice of using the trust receipt seems to have originated in the United States. 
It is not found in any other country. In the early days it was called “the red letter” be- 
cause it was generally printed in red ink to emphasize its nature and intent. The Federal 
Reserve Bulletin, January, 1922, pp. 32-37, contains an excellent discussion of the trust 
receipt. 


246 DOMESTIC AND FOREIGN EXCHANGE 


If he is to have access to the goods for the purpose of selling them 
to his customers, the following form of trust receipt will be used 


(Fig. 71): 
TRUST RECEIPT 


Berviued ftom Tar Guaranty Trust Co. or New York the following goods and mer- 
chandise, their property, specified in the Bill of Lading per S.S. 
Dated___ marked and numbered as follows: 


(Space is left here for description of merchandise) 


I 
and, in consideration thereof, — HEREBY AGREE TO HOLD SAID GOODS IN TRUST for them, 
we 
and as their property, with liberty to sell the same for their account, and further agree, in case 
of sale, to hand the proceeds to them to apply against the acceptances of Tum GUARANTY 


Trust Co. or New York on ie account, under the terms of the Letter of Credit 
our 
No. issued for a account and for the payment of any other indebtedness of 
our 


4 to Tae Guaranty Trust Go. or New York. 
aT Guaranty Trust Co. or New York may at any time cancel this trust and take 
possession of said goods, or of the proceeds of such of the same as may then have been sold, 
wherever the said goods or proceeds may then be found and in the event of any suspension, 


m 
or failure, or assignment for the benefit of creditors, on od part, or of the non-fulfillment 
our 


2 me 
of any obligation, or of the non-payment at maturity of any acceptance made by { — ? under 
us 


said credit, or under any other credit issued by Tor Guaranty Trust Co. or New Yorke on 


pas account or of any indebtedness on sl part to them, all obligations, acceptances, 

our ek our ey 

indebtedness .and liabilities whatsoever shall thereupon (with or without notice) mature 
m 

and become due and payable. The said goods while in} a hands shall be fully insured 
our 


against loss by fire. 
Dated, New York City 





FIGURE 71 
Trust receipt (goods to be held or sold by importer) 


If he has already sold the goods and wishes to deliver them upon 
arrival to the purchasers, the bank will require him to sign the form 
of trust receipt appearing on page 247 (Fig. 72). 


IMPORT AND EXPORT CREDITS 247 


If he is a customer of doubtful standing, the bank may request him 
to sign what is known as a “Bailee Receipt” (Fig. 73). This receipt 
is regarded as a little “more stringent than the trust receipt and is 
supposed to offer the bank more adequate protection. The opinion 


TRUST RECEIPT 
(FOR DELIVERY TO PURCHASER) 


Received from Tue Guaranty Trust Co. or New York the following goods and 
merchandise, their property, specified in the Bill of Lading per____-¥_»=~=~ >>> Cs lated 


marked and numbered as follows: 


In trust to deliver the same to 
who have purchased the same for. 
payable in 
and to obtain from the purchaser the proceeds of the sale of the same. 


“ - ; me |. I 
In consideration of the delivery of said goods to) = tin trust as above} a agree 
us we 


to deliver them immediately to the said purchasers, and to collect the proceeds of sale, and immedi- 


ately deliver‘such proceeds to Tue Guaranty Trust Co. or New York in whatever form collected, 
to be applied by them against the acceptances of Tuk Guaranty Trust Co. or New York on { eit 

m our 
account, under the terms of Letter of Credit No..__»____issued tor! zi account, and 


° ‘our 
to the payment of any other indebtedness of bees to Tur Guaranty Trust Co. or New York. 
ours 


It is understood, however, that if such proceeds be in notes or bills receivable, they shall not be 
so applied until paid, but with liberty meanwhile to Tue Guaranty Trust Co. or New York 
to sell or discount, and so apply net proceeds. 

Tue Guaranty Trust Co. or New York may at any time cancel this trust, and they may 
take possession of said goods until the same have been delivered to said purchasers and the proceeds 
of sale received from them, and thereafter of such proceeds, wherever the said goods and proceeds . 
may then be found, and in the event of any suspension or failure or assignment for the benefit of 


_.creditors on) sh t part or of the non-fulfillment of any obligation or of the non-payment at 
our ; 


me ; 2955 
maturity of any acceptance made by} ae funder said credit, or any other credit issued by 
Tur Guaranty Trust Co. or New York on} ~~ account, or of any indebtedness on} mrad 

our our 
part’ to them, all obligations, acceptances, indebtedness, and liabilities whatsoever shall thereupon 


(with or without notice) mature and become due and payable. 


Dated ee eee 10) 





FIGURE 72 
Trust receipt (for delivery to purchaser) 


has been expressed that any trust receipt is a priori a bailee receipt, 
and so no legal distinction exists between these two documents.” ? 


1 Federal Reserve Bulletin, January, 1922, p. 36. 


248 DOMESTIC AND FOREIGN EXCHANGE 


If the importer wishes to get the goods so that he may use them in man- 
ufacturing other products, the bank may, and often does, object to turn- 
ing them over to him on a trust receipt because of the impossibility 


BAILEE RECEIPT 


Received from the Guaranty Trust Company of New. York 


solely for the purpose of selling same for account of said Company: 


marked and numbered — 
| and___________hereby undertake to sell the property herein specified, for account of the said 
Company, and collect the proceeds of the sale or sales thereof, and deliver the same immediately on 


receipt thereof to the said Company, to be applied to the credit of. 


hereby acknowledging __________________ to be, Bailee of the said property for the said 


Company, and do hereby assign and transfer to the said 
Company the accounts of the purchaser or purchasers of said property to the extent of the purchase 
price thereof, of which fact notice shall be given at the time of delivery of the said property by 
to such purchaser or purchasers and all invoices therefor shall have imprinted, written or stamped 
hereon by________ the following: 

“Transferred and payable to GUARANTY TRUST COMPANY OF NEW YORK, 
140 Broadway, New York.” 

If the said property is not sold and the proceeds‘so deposited within ten days from this date, 


undertake to return all documents at once on demand, or to pay the value of 
|| the goods, at the Company’s option. 
my 


The said goods while in as hands shall be fully insured against loss by fire. 
our 


The terms of this receipt and agreement shall continue and apply to the merchandise above 
| referred to whether or not control of the same, or any part thereof, be at any time restored to the 
Guaranty Trust Company of New York, and subsequently delivered to us. 
| Dated at New York City, : eet 





ee 





FIGURE 73 
Bailee receipt 


of identifying the goods once they have been transformed into other 


products. 
The substance of these receipts is that the title to the goods rests in 


IMPORT AND EXPORT CREDITS 249 


the bank, that the importer is warehousing or selling them as the agent 
of the bank, and that all monies received from their sale are to be 
handed to the bank as soon as received, to pay off the importer’s 
obligation to the bank. Whether or not the bank will zmsis¢ “upon the 
application of the funds derived from the sale of the goods to the pre- 
payment of the time drafts which the bank has accepted” will depend 
in each case upon the credit standing of the importer. As a rule such 
prepayment is not demanded, but where it is, a rebate is given, similar 
to the rebate on D/P bills above described.!_ The rebate is not fixed 
“but is graduated according to such factors as credit standing of 
customer, time of maturity, and prevailing value of money. Whether 
dollar, sterling, or foreign acceptances, the rebate is actually governed 
by the rate of the central bank. It may be determined directly by 
placing the rebate at 1 or 2 per cent below the discount rate of the 
Federal Reserve Bank in the case of dollar acceptances, or a little 
below the rate of.the Bank of England for sterling bills. Another 
method is to allow a certain per cent below the market rate for prime 
bankers’ bills. A third way is to grant the customer the same rate of 
interest allowed on deposit accounts.” ? The trust receipt also au- 
thorizes the bank to cancel the trust at any time and to take actual 
possession of the goods in order to protect itself against loss. 

Sometimes the goods arrive before the documents, in which event 
the bank usually releases the goods to the importer so as to save ware- 
housing charges, and also to save perishable goods from spoiling. The 
_ bank under such circumstances takes a trust receipt from the importer, 
also a statement that he accepts the goods even though the shipment 
prove to be somewhat irregular. The importer is also required to give 
the customs and steamship officials a bond of indemnity before being 
allowed to remove the goods without presenting the documents.® 

There is considerable difference of opinion among bankers regarding 
the value of a trust receipt. By many it is considered a “necessary 
evil”’ that should be replaced by some more satisfactory method of 
protecting a bank’s right to the property which it surrenders. As 
Escher so cogently remarks: 


“A large volume could be written on the subject of trust receipts and 
the litigation which has grown out of the attempt to enforce them, but the 
1Cf. p. 144. 


2 Federal Reserve Bulletin, February, 1921, p. 168. 
3 Ibid, p. 167. 


250 DOMESTIC AND FOREIGN EXCHANGE 


whole sum and substance of it all would be that the trust receipt is just 
about as good as the party who signs it and no more. Bankers who hand 
over the documents on trust receipt (and an immense volume of business 
is so handled annually) do it almost entirely on the standing and credit of 
the party receiving the goods and hardly at all on the idea of being able to 
earmark and recover the merchandise or its proceeds in the event of failure. 
Nor has the rating of the importer as much to do with the banker’s being 
willing to let him have the documents against trust receipt as might be 
imagined. Many a firm of known large resources has trouble getting the 
banks to let it have the bills of lading against a straight trust receipt; 
whereas, many a firm whose resources are admittedly nowhere near as 
large have no trouble whatsoever. The importer’s business and particu- 
larly the way he runs his business—that is what counts. What it comes 
down to is very much the same as though the importer were going to the 
bank and asking for a loan. Just about the same things are taken into 
consideration.” 2 


To date the legal status of the trust receipt remains undecided. 
Federal courts have upheld the rights of the bank under the trust 
receipt on the basis of the trust receipt being a commercial necessity. 
Very little agreement can be found among the decisions of state courts, 
and as a result banks have been seriously limited in their efforts to 
maintain their rights over property released on such documents. ? 

To revert to our illustration: The American Importing Company 
gets the goods under a trust receipt and either prepays its indebted- 
ness to the Guaranty Trust Company under the rebate system as al- 
ready discussed, or waits until the maturity of the draft before putting 
the Guaranty Trust Company in funds with which to meet the ob- 
ligation which it (the bank) has incurred on behalf of the importing 
company. The latter must also pay the commission of the accepting 
bank as well as any extra charges the accepting bank may have to 
meet. The commission of the American bank for accepting drafts 
drawn on it in terms of dollars will vary as between clients, and also 


1 “But whatever the form of the contract, it is to be borne in mind that when the banker 
issuing the credit hands over the bill of lading to the importer on trust receipt, he is allowing 
the only security he has to pass out of his hands, and is putting himself in the position of 
having made an unsecured loan to the importer.’’ Escher, ‘‘ Elements of Foreign Exchange,” 
p. 1§2. 

2Escher, ‘Foreign Exchange Explained,” p. 126. The Federal Reserve Board, in its 
Regulations C Series of 1920, declares that ‘‘A trust receipt which permits the customer 
to have access to or control over goods will not be considered by Federal Reserve Banks 
to be ‘actual security’ within the meaning of Section 13” of the Federal Reserve Law. 

3 Cf. Federal Reserve Bulletin, January, 1922, p. 33. 


IMPORT AND EXPORT CREDIT 251 


as to the usance of the drafts. The customary commissions are 
sight, 1/8 per cent; 30 to 60 days, 1/4 per cent; 90 days, 3/8 per cent 

When the draft matures, the holder, whoever that may happen 
to be, presents it to the Guaranty Trust Company and receives its 
face value. In the example which we have been following, it is readily 
seen, as has been true of the other examples of acceptances earlier dis- 
cussed, that it is the discount market which advances the funds with 
which the transaction is financed. The accepting bank uses none of 
its funds, it simply advances its credit; the importing firm uses none 
of its funds, it employs the credit of the accepting bank. The exporter 
gets his money when he sells his documents to the Japanese bank. 
The Japanese bank in the above example, advances the funds only 
temporarily because it has the bill discounted as soon as it is accepted. 
When it buys the bill from the Asaki Silk Company it does so at a 
rate calculated to net it a profit. As soon as the draft has been ac- 
cepted, the Japanese bank shifts the burden onto the discount market 
by selling the draft to some party willing to buy it as a short time 
investment. The latter carries the obligation until its maturity, but 
receives in return the current rate of discount for a banker’s acceptance. 

The fact must not be overlooked that the liability of the drawer and 
of the indorsers continues until the transaction has been concluded 
by the payment of the draft by the Guaranty Trust Company. 

When exports from the United States are financed by means of a 
commercial letter of credit issued in terms of the money of the foreign 
country to which the goods are to be sent, the practices followed are 
along the same general lines as those outlined above.! To give a 
concrete example, let us have the Anglo Automobile Company of 
London arrange with the American Truck Company of New York 
for a shipment of automobiles. The Anglo Automobile Company 
goes to its bank, say Barclays, and secures a sterling letter of credit, and 
mails it to the American Truck Company. The latter prepares the 
shipment, gets all the documents required, draws its draft in pounds 
sterling on the English issuing bank, and sells the draft, i. e., discounts 
it for dollars at a New York bank. The latter sends the documentary 
bill to its correspondent in London, which presents it for acceptance 

1“Tn these days of restricted exports an increasing number of cases are apparent where 
foreign buyers prefer to open credits through their own banks in terms of their own cur- 
rency. Hesitancy on the part of American exporters in accepting such credits in foreign 


currency has, in many instances, resulted in loss of current business.’ Foreign Trade 
Bulletin of the American Express Company, June, 1921. 


252 DOMESTIC AND FOREIGN EXCHANGE 


to Barciays. The latter accepts the draft, and retains the documents. 
The correspondent bank, acting upon instructions from the New York 
bank, either holds the draft until maturity or discounts it in the open 
market. Barclays hands the documents to the Anglo Automobile 
Company against a trust receipt or other form of security. The Anglo 
Automobile Company gets the goods, sells them, and puts the bank 
in funds with which to meet the payment of the draft when presented 
at maturity by the party holding it at that time. The importing firm 
also pays the accepting bank its commission for having advanced its 
credit during the period of the transaction. If the American Truck 
Company were located in Detroit instead of New York, an additional 
step in our story would have to be added provided the Detroit bank 
to which the documents had been sold had no direct London connec- 
tions. The Detroit bank would have to indorse the documents and 
discount them with a New York bank, and the documents would then 
follow the course outlined above. Or the Detroit exporting company, 
having a number of similar shipments to make during the year, might 
arrange directly with a New York bank to take all its exchange at the 
prevailing market rates. Under such conditions, the exporting com- 
pany draws a draft in sterling against a shipment, after wiring the 
New York bank for the rate which it is willing to pay. The exporting 
firm then converts the amount of its sterling draft into dollars at the 
quoted rate, and draws a draft for that sum in dollars on the New 
York bank. It then hands the sterling draft and documents and also 
its dollar draft to its local bank. The latter may credit the exporter 
immediately with the value of the dollar draft or may take it for col- 
lection. In either case, the local bank sends the shipping documents, 
the sterling draft and the dollar draft to the New York bank. The 
New York bank pays the dollar draft by crediting the account of the 
Detroit bank with that sum. The New York bank sends the sterling 
draft and documents to its correspondent in England, and from this 
point, the procedure is the same as outlined above. Or it may be 
that the Detroit exporter has made arrangements with a New York 
exchange dealer through whom it is able to market all of its documen- 
tary exchange at better rates than it could if it dealt only with one 
New York bank. The exchange dealer will secure the best market 
rate for the exporter, and wire a notice of the rate quoted and to what 
bank the exchange has been sold. The exporter then draws a dollar 
draft on that bank, as in the case just cited, hands the dollar draft 


IMPORT AND EXPORT CREDITS 253 


and the sterling bill with accompanying documents to the local bank 
which forwards them to the New York bank, giving the exporter im- 
mediate or deferred credit for its dollar draft. From this point, the 
New York bank handles the bill as above described. The New York 
exchange dealer receives a small commission for marketing the 
exporter’s bill at the best obtainable sterling rate. The last two 
methods are customarily employed where the exporter has to dispose 
of a large amount of documentary exchange. 

In the cotton trade it is a more or less common practice for the im- 
porter not to furnish the exporter with a letter of credit. Trading in 
cotton is for the most part in the hands of responsible firms and all 
that is necessary is for the importer to wire the exporter the name of 
the London bank upon which his drafts are to be drawn. American 
bankers, knowing these firms and their excellent reputation, buy the 
cotton bills of the exporters without question because they feel that 
“their implied word when offering the bills for sale is sufficient guar- 
antee that the London banks will honor the bills with their accept- 
ance.”’ + 

It is not unusual for an American importer to be required to obtain 
a commercial letter of credit drawn in terms of a foreign money be- 
cause of the customs of trade in the exporting country, or because 
drafts drawn in terms of a foreign currency command a higher rate in 
the foreign market, or because of some other reason. Before 1916 
American banks were not permitted to accept drafts drawn on them 
in connection with the financing of foreign trade. It therefore fol- 
lowed that they could not issue commercial letters of credit except as 
agents of foreign banks. Drafts in all cases had to be drawn against 
foreign banks. American banks acted only as the intermediary in 
supplying the American importer with his letter of credit. With 
England supreme in the trading and financial world and with the 
sterling draft more readily discountable than drafts drawn in other 
monies, the sterling letter of credit was the type most commonly used, 
not only by English importers, but by importers throughout the world. 
American firms importing goods from South America, the Orient, 
Europe, or Australia employed the sterling letter almost exclusively, 
although at times the mark or the franc letter was used. Estimates 
of the commissions which we paid annually to English bankers for 
their acceptance of our long sterling bills vary from a minimum of 

1 York, op. cit., p. 130. 


254 DOMESTIC AND FOREIGN EXCHANGE 


$10,000,000 ! to a maximum of $150,000,000.”. The practice of paying 
for imports by means of sterling drafts drawn on a London bank is 
still followed rather universally by all trading countries. Even, for 
example, where a Peruvian sells sugar to a Chilean firm, the goods are 
paid for by means of a 90 day draft on London. South American firms 
frequently remit sterling drafts to exporters in the United States or 
send sterling letters of credit to us; and when we export goods to them, 
we not uncommonly draw our drafts on London banks and in terms 
of sterling. Since 1916, however, we have made substantial progress 
toward popularizing the “dollar” letter of credit, especially among 
our exporters. The fluctuating exchanges were primarily responsible 
for the rather rapid development of this form of credit. American 
houses engaged in shipping goods abroad wanted to be assured of a 
definite return on their drafts. With the foreign exchanges fluctuating 
so adversely from day to day, our exporters stood to lose on their 
shipments. They then began to ask foreign importers either to es- 
tablish dollar credits in the United States or to forward a dollar letter 
of credit issued by the importer’s bank on an American correspondent. 
Under such letters of credit the draft is drawn in dollars on the Ameri- 
can bank, accepted by it, and then discounted in the American market. 
At maturity the holder is paid by the American bank out of funds: 
supplied by the foreign importer and forwarded to the American ac- 
cepting bank by the foreign bank that had issued the dollar letter of 
credit. Such dollar letters of credit, however, have been used only 
to finance trade into or out of the United States and have never been 
employed, so far as I have been able to ascertain, to finance ship- 
ments between other countries, such as from Brazil to Portugal, or 
from China to France. 

The progress that was made in developing the use of the dollar 
acceptance credits is nicely pictured by the following report of the 
Acceptance Committee of the American Bankers Association, pub- 
lished in May, 1921: 


“Your committee is pleased to report that marked progress has been 
made with the development of certain phases of the American acceptance 
method of financing in the past half-year. Hundreds of banks, individuals, 
firms and corporations have been converted during that period to the idea 

1 Pamphlet on ‘“‘Acceptances”’ issued by the American Exchange National Bank of New 
York) (39275 Da 13, 


2 Statement by Prof. E. E. Agger in the Nationa! City Bank of New York Correspondence 
Course in Foreign Exchange. 


IMPORT AND EXPORT CREDITS 255 


of investing temporarily available funds in bankers’ acceptances. Prime 
bankers’ acceptances are now regarded as a dependable reserve. The open 
discount market here has become a reality—every interest in America is 
benefitting from its operations. Dollar credits have gained preference 
everywhere. Many commercial banks have qualified for the utilization 
of their full acceptance powers. New and substantial acceptance houses 
have been organized and plans have been perfected under which funds 
are now being loaned on call or demand against acceptances as collateral 
in preference to stocks, bonds, and other long-term securities. 

“Through the use of and investment in acceptances funds heretofore 
idle and practically useless are being mobilized and made to serve com- 
merce and industry. Over-night money, spot and forward rates and other 
discount market terms so well known abroad are rapidly finding their way 
into our business and financial vocabulary . . . The bankers’ acceptance 
method has been thoroughly tested here; its merits are established, and, 
if it is honestly applied, allowed to develop along natural lines and is not 
stifled by over-regulation, its further success is assured. According to 
figures compiled by the American Acceptance Council, the volume of 
bankers’ acceptances outstanding April 1, 1921, was approximately $665,- 
000,000, while the volume one year ago was $800,000,000. Considering 
the slump in our exports and the drop in prices, this showing is highly satis- 
factory. The drawings to create dollar exchange have shown a notable 
increase. The discount rates on prime bankers’ acceptances for the six 
months’ period ranged from 5 1/2 to 6 3/8%. Dealers buying rates from 
5 5/8 to 6 3/8%. Dealers selling rates from 5 1 / 2to61/4%. Acceptances 
call or demand loan rates ranged from 4 I i 2 to 6%. The commission 
charged by banks on acceptance credits ranged from 1 to 1 1/2% (%4 to 
3/8% for ninety days), varying with the character of the transaction cov- 
ered and risk involved.” 


Even as yet, in spite of the opportunities that arose during the 
World War, American bankers have not become experienced in the 
financing of foreign trade. Our interest and commission charges are 
usually higher than those of foreign bankers. Our exchange or dis- 
count market is not so thoroughly developed as that of London. 
America bankers are but slightly versed in the purchase and sale of 
acceptances. All of these matters, however, are of a comparatively 
recent growth, and as with the passage of years the rough places are 
ironed out, our dollar credits may be able to compete successfully 
with sterling credits. In spite of these shortcomings, a large pro- 
portion of our exports and imports is being financed at present by 
“dollars”’ as a result of the depreciation and uncertainties of the foreign 


256 DOMESTIC AND FOREIGN EXCHANGE 


exchanges, but during the last two years sterling credits have been 
regaining their former place of supremacy. This is inevitable, of 
course, for the long standing tradition of sterling exchange and the 
familiarty of foreign 
exporters with London 
bankers and accepting 


The Anglo & London Paris National Bank 3 
houses cannot be easily 


OF SAN FRANCISCO 


[2600S CREDIT NOx3467___ 


San F; raieed, MOE Be 5023, 


TO... Pranco..Exporting..Company.....—— 

EORED FP RROO ee ee 
We hereby authorize you to value on MESSRS. LAZARD BROS. & CO., LTD. 11 Old Broad St, 
London = ae Ot Lo ty..deys..sight____ -.for account of 


American Lace. Company, San Francisoo, California .____ ___up ta an aggregate 


amount of five thonsand pounds. sterling (45,000) mag he 


Vv 
Bane 


for invoice cost of. Jaga——_._.-_-____ = 


Aa ek Mov beat ae See 


h to be shipped to... The American Jace. Company,.34 Rattery Street, San. Franaisco,. 
Gals orn ae ene 


Bills of Lading for such shipments must be made out to the order of The Anglo & London Paris Nationa) 
Bank of San Irancisco. 


Consular Invoice and One Bill of Lading must be sent by the Bank or Banker oegotiating the draft 
direct to The Anglo & London Paris National Bank of San Francisco, by mail, attaching to the draft a state 


ment to that effect. The remaining documents must accompany the draft drawn on London 
The amount of each draft negotiated, with date of negotiation, must be endorsed on the back hereot 


We hereby agree with the bona fide holders that all drafts issued by virtue ofthis credit and m 
accordance with the above stipulated terms shall meet with due honor upon presentation at the office af MESSRS. 
LAZARD BROS. & CO., LTD.., if drawn and negotiated prior to_July.1,.1921. 


Drafts under this credit must state that they are drawn under Lettcr of Credit No. 3467. __. 


ofA. & L. PLN. B. dated... May 12,1921. 


{nsurance to bo. effected by shipper 


THE ANGLO SSCONDON Pas NATIONAL BANK. 
> 


9 > 
a Fe 


% 


— a i eS 





FIGURE 74 
Sterling import letter of credit 


overcome. 

When an American 
bank issues a sterling 
letter of credit to an 
importer, it custom- 
arily issues the letter 
either against its own 
London’ branch or 
directly against a cor- 
respondent bank in 
London with which 
it has previously made 
arrangements regard- 
ing such matters.! 

Suppose that the 
American Lace Com- 
pany of San Francisco 
wishes to import a ship- 
ment of laces from the 
Franco Exporting 
Company of Paris, and 
that it has been noti- 
fied by the exporter to 
send a £5,000 letter of 


credit to cover the costs. The American Lace Company obtains 
from the Anglo and London Paris National Bank a commercial letter 
of credit on Lazard Brothers of London (Fig. 74). 

The letter may be made out in duplicate or in quadruplicate. If 
in duplicate, one copy goes to Lazard Brothers as an advice, notifying 


11t is possible, though not customary, for an American bank to issue a sterling letter 
of credit upon itself. In that case the foreign exporter draws a sterling draft on the Amer- 
ican bank, sells it to his local bank; it is then forwarded to the American bank for accept- 
ance, which pays it at maturity by a dratt in pounds sterling drawn on its London account. 


IMPORT AND EXPORT CREDITS 257 


them of the contents of the letter that has been issued; the second 
copy is given to the purchaser, which forwards it to the Franco Export- 
ing Company. The bank keeps its own record of the transaction 
and may also give a receipt to the purchaser for its files. When four 
copies of the letter are issued, one goes to Lazard Brothers, one is kept 
by the bank for its record, one is sent abroad to the exporter, and the 
remaining one is kept by the importer for its files. Or, of the four 
copies issued, two may be sent by separate steamers to Lazard Brothers 
and the other two copies in like manner to the Franco Exporting 
Company. 

-If the exporter demands that the letter of credit be actually con- 
firmed by Lazard Brothers in order to make sure that the latter 
assumes the obligation placed upon it by the Anglo and London Paris 
National Bank, Lazard Brothers will give such a confirmation to the 
French exporter, charging therefor from 1/20 to 1/8 of one per 
cent of the face value of the letter, to be paid, of course, by the im- 
porter. 

When the Franco Exporting Company has prepared the shipment 
as per agreement with the American Lace Company, and has ob- 
tained the various documents as per the requirements of the letter of 
credit, it draws a go day draft on Lazard Brothers for £5,000, the value 
of the shipment. It presents the draft and documents to its banker, 
say the Crédit Lyonnais, and receives £5,000 worth of francs at the 
rate of the day for that type of sterling bill. If the rate happens to be 
25.51 francs per pound sterling, the Franco Exporting Company 
receives 127,550 francs (Sooo X 25.51). The Crédit Lyonnais in ac- 
cordance with the directions in the letter sends the consular invoice 
and one copy of the bill of lading direct to the Anglo and London 
Paris National Bank of San Francisco ' and at the same time attaches 
a statement of that fact to the draft, which must be sent with the 
remaining documents to its correspondent in London to be presented 
to Lazard Brothers for acceptance. The documents which accompany 
the draft are sent merely to show that the shipment has been made 
in accordance with the terms of the letter. Lazard Brothers accept 
the draft, detach the documents, and return the accepted draft to the 
correspondent of the Crédit Lyonnais, which holds it until maturity 
or has it discounted immediately, depending upon instructions which 


1 The French bank is willing to do this because it has no reason to question the solvency 
and good faith of the San Francisco bank. 


258 DOMESTIC AND FOREIGN EXCHANGE 


it has received from the Paris bank. Lazard Brothers may or may 
not send the documents to the San Francisco bank, depending again 
upon instructions. There is no need that they be forwarded, for the 
San Francisco bank has a copy of the bill of lading which has been 
sent to it direct by the exporter’s bank, and which will enable the 
importer to get the goods off the wharf. When the draft has been 
accepted, Lazard Brothers notify the San Francisco bank so that the 
latter may know the maturity date of the draft. 

When the documents and the goods reach San Francisco, the bank 
notifies the importer. The latter gives the bank a trust receipt or 
makes some other such arrangements whereby it is enabled to get 
possession of the goods. At the end of a certain time, usually about 
fifteen days before the accepted draft must be paid in London, the 
bank notifies the American Lace Company to deposit with it a sum 
in dollars which at the prevailing banker’s sight rate for sterling ex- 
change will be sufficient to purchase a £5,000 demand draft plus all 
commissions and charges. The commission of the English accepting 
firm will vary from nothing to % per cent or more, determined by the 
usance of the bill, the reputation of the parties concerned, the nature 
of the goods shipped, the competition of banks for the business, etc. 
American banks fix their commissions so as to include those charged 
by the English accepting bank. The total commission will range from 
14 per cent for the sight drafts to about 3/8 per cent for go day 
drafts, the arrangement between the English acceptor and the Ameri- 
can bank usually being that the returns shall be divided evenly. If 
the face value of the draft plus the commissions and charges amounts 
to £5,040, and if the rate for demand drafts in the market is 4.86, 
the American Lace Company. will have to pay the San Francisco 
bank the sum of $24,494.40 (5,040 X 4.86). The bank will then put 
Lazard Brothers in funds by sending a demand draft, or by waiting 
a few days and sending a cable, or by instructing Lazard Brothers 
to debit its account for the amount of the draft plus their commission. 
In any event, funds are on hand with which Lazard Brothers pay the 
draft when presented at maturity by the holder. 

The greater portion of the world’s trade is still financed by sterling 
bills of this character, and that condition will remain so long as Eng- 
land is dominant in foreign trade through her merchant marine and 
her far-flung system of foreign branch banking. A ready market for 
sterling drafts always prevails, no matter in what part of the world they 


IMPORT AND EXPORT CREDITS 259 


are drawn, because bankers and others with obligations to meet in 
London are continually in the market for sterling exchange. Letters 
of credit, handled in the above manner, are also issued in terms of 
francs, in which case the drafts would be drawn on a French bank and 
accepted by it, or in marks, with the drafts drawn on a German bank 
and accepted by it, or in lire, florins, etc. 

Revolving Letters of Credit. Occasions sometimes arise which make 
it advisable for the importer to obtain a “revolving” letter of credit 
rather than the ordinary commercial letter of credit. He may be 
importing continually from some foreign house and does not want to 
be bothered with getting a letter for each lot of goods imported, or 
possibly the bank does not want to issue to him a letter of credit for 
an amount large enough, or for a period long enough, to cover his 
importations. To meet such contingencies, the banking world had 
developed a “revolving” letter of credit which meets such conditions 
admirably. Revolving credits are issued under the same terms and 
on the same type of form as the ordinary commercial letters of credit 
that we have discussed, the only difference being that a description 
of the conditions under which the credit is to revolve or be renewed 
is incorporated in the letter. Revolving letters of credit may be divided 
into four general groups. (a) The credit may be opened for, say, 
$50,000 with the agreement that the draft is to be for the total 
amount of the credit, and that the credit is to be automatically re- 
newed as soon as the draft is paid. (b) The credit may be opened for, 
say $50,000, with the understanding that the total amount of drafts 
outstanding at any one time shall not exceed that sum. For exam- 
ple, the exporter may draw any number of drafts against the letter of 
credit up to the sum of $50,000, but no more may be drawn until some 
of those outstanding have been paid. As they are paid, the accepting 
bank advises the exporter of the payments and he may then draw 
additional drafts up to the amount of those that have been paid, but at 
no time may there be more than $50,000 worth of drafts outstanding 
and unpaid. (c) The credit may be opened on the condition that 
when the exporter draws a draft for any amount within the limit set 
by the letter, say $50,000, the credit becomes immediately available 
for the fullsum. Thus if the exporter should draw a draft for $40,000 
under the terms of this type of revolving letter, as soon as he had 
drawn such a draft, the letter would be automatically renewed for the 
entire amount. In types (a) and (b) the act of paying the draft or 


260 DOMESTIC AND FOREIGN EXCHANGE 


drafts renews the letter, but in type (c) the act of drawing the draft 
renews the letter. (d) The letter may be drawn authorizing the 
exporter to draw for a certain amount weekly, monthly, or annually. 
This type of letter may be accumulative or non-accumulative, i. e., if 
the amount specified is not drawn each week, month, or year, the sum 
that is not drawn may be allowed to accumulate and become available 
for the next period (accumulative); or if not drawn, the beneficiary 
loses the right to draw for the lapsed amount (non-accumulative). 

The convenience and usefulness of revolving letters of credit are 
clearly evident and do not need elaboration. The commission charged 
by the issuing bank is based, not on the amount for which the credit 
is issued, but on the amount that is availed of thereunder. 

Export Letters of Credit. Situations arise at times in which the ex- 
porter is compelled to take the initiative in obtaining an export letter 
of credit or an export credit that may be known by some other name. 
It may be that a.South American or Asiatic importer finds himself un- 
able to obtain an import letter of credit because of the lack of banking 
facilities, or he may know that he will be unable to obtain dollar ex- 
change when he wishes to remit payment with his order. The ex- 
porter always wants to get his money for the goods as soon as they are 
shipped. The practice of drawing directly upon the importer is 
seldom employed. Various forms of export credits have been devised 
for use in foreign trade. Previous to the establishment of the Federal 
Reserve System almost all export credits were in terms of sterling. 
Lately, however, as a result of the World War and also because Ameri- 
can banks since 1916 have been authorized to finance trade by means 
of acceptances, an increasingly large amount has been drawn in dollars. 

Suppose that Lima and Company of Rio de Janeiro desires to im- 
port $10,000 worth of goods from the New York Machinery Company. 
The latter is willing to ship the goods with the understanding that 
they are to be paid for thirty days after the acceptance of the draft. 
The exporter consults with the Chase National Bank of New York 
as to the best method of financing the shipment. An arrangement 
is entered into whereby the exporter is to hand all documents to the 
bank; the draft is to be drawn at thirty days sight; documents are to 
be turned over to the importer on acceptance or on payment, as the 
case may be, and the exporter is to receive in return a sterling export 
letter of credit. When the documents have been prepared, and the 
draft drawn in sterling on Lima and Company payable to the Chase 


IMPORT AND EXPORT CREDITS 201 


National Bank or order at thirty days sight, the exporter hands his 
documentary bill of exchange to the bank, and receives in return his 
export letter of credit. By its terms he is authorized to draw a ninety 
day draft on the London correspondent of the Chase National Bank, 
say Barclays, for ninety per cent of the invoice value of the goods. 
He may then sell this draft in the open market and receive dollars for 
it, or he may have the bank draw the draft and sell it in the market 
and turn the dollars over to him or to his account on deposit with the 
Chase National Bank. If the bank draws and sells the draft a larger 
return will be obtained because the bank’s draft will command a 
higher price than will the draft of the exporter. The New York bank 
that purchases the draft, say, the United Trust Company, sends the 
draft to its London correspondent, say, Lloyds, which presents it to 
Barclays for acceptance. Barclays accepts the draft in accordance 
with the “advice” forwarded to it by the Chase National Bank. The 
draft then runs to maturity. In the meantime, the Chase National 
Bank forwards the documents covering the shipment to its correspond- 
ent at Rio de Janeiro, say the Banco do Brasil, with instructions to 
present the draft of the New York Machinery Company to Lima and 
Company for acceptance. Lima and Company accepts the draft, gets 
the goods, and disposes of all or part of them. Some time elapses 
before the goods and the documents reach Rio de Janeiro, perhaps 
twenty-five days; the draft runs for thirty days. At the end of that 
time ' Lima and Company is required to pay the Banco do Brasil 
an amount of milreis sufficient to purchase a sterling demand draft 
on London, called the “return bill” or “return draft.’’ The Banco do 
Brasil charges a commission for acting as the agent of the Chase Na- 
tional Bank, and includes that charge in the rate which Lima and Com- 
pany pays for the demand draft on London. The stamp taxes also 
have to be paid by the importing firm.?, The Banco do Brasil then 
forwards the draft to Barclays in London as per instructions from 
the Chase National Bank, thus putting the accepting bank (Barclays) 
in funds with which to meet the draft which it (Barclays) had earlier 
accepted. It will be noted that the draft drawn by the exporter on 
Barclays was a ninety day draft but for only ninety per cent of the 


1I£ payments are made before maturity of drafts it is customary in South America to 
allow a rebate of 6 per cent on such pre-payments. 
-2 Stamp taxes are imposed on commercial invoices, receipts, bills of lading, indorsements 
on the same, and upon practically all documents, legal or otherwise, in all South American 
countries. 


262 DOMESTIC AND FOREIGN EXCHANGE 


value of the goods. The draft drawn by the exporter on Lima and 
Company was a thirty day draft for the full value of the shipment. 
The demand sterling draft sent from the Banco do Brasil to Barclays 
was for the full value of the shipment. It takes about twenty-five days 
for the mail to reach London from Rio de Janeiro, so that the demand 
sterling draft has sufficient time to arrive in London and thus put Bar- 
clays in funds before the exporter’s draft on Barclays matures and has 
to be paid. Barclays cashes the demand draft sent it by the Banco do 
Brasil, pays its accepted draft at maturity and deducts from the 
remainder its usual acceptance commission. It then forwards the 
remainder to the Chase National Bank in the form of a dollar draft, 
or it may simply credit the Chase National Bank with the amount 
in question and send an advice to that effect. The Chase National 
Bank deducts its commission for having acted on behalf of the ex- 
porter and pays him whatever remains. Thus it happens that no 
bank advances any funds. The transaction throughout is purely 
of a credit character. The London discount market again carries the 
financial burden, and, as always, at its usual discount rate. The ex- 
porter has to pay two commissions, one to the London accepting bank 
(Barclays) ‘ against which the export letter was issued, and one to the 
Chase National Bank,” but in return therefor he has the use of the 
money for at least ninety per cent of the value of the shipment during 
the period covered by the transaction. The exporter is willing to wait 
for the remaining ten per cent until the deal has been closed. The 
risk of exchange has been borne in this case entirely by the importer, 
for it is Lima and Company that has to buy sterling exchange at the 
market rate in Rio de Janeiro with which to put Barclays in funds 
wherewith to meet the exporter’s draft. 

With the changes wrought by the Federal Reserve Act, it is now 
possible for an exporter to draw the draft on an American bank in- 
stead of on an English bank. Taking the data of the above example, 
the exporter under this arrangement draws the draft in dollars on Lima 
and Company, payable in exchange on New York at the Brazilian 
bank’s sight rate, and turns the draft and documents over to the 
Chase National Bank which forwards them to the Banco do Brazil in 
Rio de Janeiro. The draft will be accepted by Lima and Company 
and will run for the designated period. The exporter, at the same 


1 Possibly from 1/8 to 3/16 of one per cent. 
2 Usually 1/2 of one per cent for a ninety day acceptance. 


IMPORT AND EXPORT CREDITS 263 


time, also draws a draft in dollars against the Chase National Bank 
for 90 per cent of the invoice value of the shipment. The latter is 
accepted by the drawee (the Chase National Bank) and possibly dis- 
counted by it, although it is not advisable for a bank to discount its, 
own acceptances. More often, after the Chase National Bank has 
accepted the draft, the exporter discounts it in the New York market, 
say with the National City Bank. Before the draft matures, Lima 
and Company puts the Banco do Brasil in funds by paying the draft 
drawn by the exporter. The Brazilian correspondent bank then puts 
the Chase National Bank in funds so that the exporter’s second draft, 
i. e., the one which he drew on the Chase National Bank itself, may 
be paid when presented t maturity by the National City Bank. 
There are other methods of financing exports from one country to 
another by means of drafts drawn on a third country, but without the 
use of a commercial letter of credit. For instance, say the New York 
Machinery Company as per instructions sent it, draws a go day sterling 
draft on Lima and Company for enough sterling at the prevailing 
market rate for 90 day bills to yield the dollar value of the goods plus 
certain charges for interest and commission that the negotiating bank 
imposes. The bank’s commission will usually be 14 per cent, and the 
interest charges ! will be figured customarily at 6 per cent and for the 
length of time that it will take the draft to reach Rio de Janeiro, be 
accepted and run to maturity of go days, plus the time that it will 
take for the remittance to reach New York (calculated in all at 140 
days). If the rate is 4.81 7 for 90 day sterling drafts, and if the total 


1 Sometimes the face value of the draft will be discounted by the bank instead of interest 
being charged. The former, even though the same rate be employed, yields the exporter 
a slightly smaller sum. 

American banks charge a “‘flat rate of from 134 to 5 7/8 per cent for discounting drafts on 
South America, depending upon the tenor of the draft and the time and distance from 
New York to the country upon which the item is drawn. These rates are made up in this 
manner for general convenience in calculating and are arrived at by charging interest for 
the estimated time elapsing between payment of funds by the discounting bank and date 
of reimbursement in New York. To illustrate; if the draft be drawn at go days sight on 
Buenos Aires, an additional two months’ interest is added to the 90 days to cover the 
estimated time in transit to and from that point. The bank reserves the right to adjust 
the interest charge with the drawer of draft should the elapsed time be longer than the 
time estimated. 

“To some countries there is also added the foreign bank’s collecting charge for drafts, 
plus foreign revenue stamp tax on bills of exchange. These charges range from 1/20 to 
1/5 of one per cent. Malley, F. O., “Our South American Trade and Its Financing,” 
New York, 1920, issued by the National City Bank, p. 29. 

2 Speaking of conditions before the Great War, the Americas (vol. 1, No. 3, p. 47) states 
that ‘‘For South American business, it is the custom, generally, to figure a rate of exchange 
of $4.80 for all transactions, owing to the fact that this is a well-ingrained usage with which 


204 DOMESTIC AND FOREIGN EXCHANGE 


yield that the draft is to bring is $10,258 ($10,000 value of goods plus 
$233 interest at 6 per cent for 140 days plus $25 commission of the 
negotiating bank at % per cent), the draft will have to be drawn for 
£2132 128 8d (10,258 + 4.81). The Chase National Bank gives the 
exporter $10,000, takes the draft and documents and forwards them 
to the Banco do Brazil. The draft is presented to Lima and Company 
for acceptance, and at the end of go days is paid by that firm in the 
exact amount of milreis required to buy a sight draft for £2132 12s 8d 
on London. If the rate is high, Lima and Company has to pay more 
milreis; if it is low, the firm has to pay less. The draft is then for- 
warded to the Chase National Bank, or, if the latter so desires, it may 
have the draft sent to its correspondent in London, there to be cashed 
and credited to its account. If the draft is forwarded to the Chase 
National Bank, instead of to London, the bank can either sell it to 
another exchange dealer in New York at the current rate for sight 
drafts on London, or it can forward it to London for collection, the 
proceeds to be credited to its account. It will follow the course that 
seems to promise the greater profit. In either case the Chase National 
Bank assumes the possibility of a decline in the rate for sterling ex- 
change, and a corresponding decrease in its profit on the transaction. 
In the two instances, where the sterling draft is sent to London to build 
up the account of the New York bank so that exchange may be 
drawn against it, the rate for sterling may fall so low as to cause a loss 
to the Chase National Bank. Likewise, in the other instance where 
the draft is returned to New York and the bank sells the draft to 
another local dealer, sterling exchange may fall, and entail a loss to the 
bank. Of course, conversely, there are chances that the rate for ster- 
ling may rise and thus bring larger profits than anticipated. 

It is possible for this latter method to be financed in terms of dollars. 
As an illustration, say the New York Machinery Company draws 
a dollar go day draft on Lima and Company, payable to the Chase Na- 


South Americans are thoroughly familiar. Naturally, it suits very well in the case of a 
shipment of goods against sight drafts because, as a rule, they can always be sold to a better 
advantage than $4.80 in this market. However, if the draft were 90 days sight, it would 
not at all times bring $4.80 and it would be necessary, in making a price for goods, to bear 
that fact in mind. The rate is a matter of custom only. Rate making on the invoices 
can be adjusted satisfactorily to both the importer and the exporter. The rate of $4.80 
on a sight draft in sterling on South America is favorable to the United States exporter, 
as it means about $4.85, if the voyage to and from is counted as 60 days at 6 per cent, 
making about five points difference or approximately 1 per cent. The banker purchasing 
it takes the risk in exchange.” 


IMPORT AND EXPORT CREDITS 265 


tional Bank or order, and payable (in Brazilian currency) at the rate 
being charged on the maturity date by the Brazilian bank for dollar 
sight drafts on New York. The draft is drawn to include the bank’s 
commission of 14 per cent and interest at 6 per cent for the period of 
140 days plus the invoice value of the goods, totalling, say, $10,258, 
and is sold to the Chase National Bank. The draft and the documents 
then take the same course as in the last example, i. e., they are sent 
to the Banco do Brasil, the draft is accepted by Lima and Company 
and runs for go days, at the end of which time the importing firm pays 
the Banco do Brasil a sum of milreis sufficient to purchase a $10,258 
demand draft on New York. The commission of the Banco do Brasil 
is included in the rate that it charges the importer for the dollar sight 
draft on New York, or it is obtained in some manner from the Chase 
National Bank. The demand draft for $10,258 on a New York bank 
is then forwarded to the Chase National Bank and cashed by it at the 
bank upon which the draft has been drawn. 

In the last two examples, the Chase National Bank of New York 
has advanced its own funds during the life of the transaction, and has 
therefore charged interest as well as its commission. In the earlier 
examples, the Chase National Bank loaned only its credit to the ex- 
porting firm, and it was the discount market of London or of New York 
that bore the burden of financing the transaction. Normally, banks 
much prefer to follow the latter practice, because to them the loaning 
of credit is always more acceptable than the loaning of actual funds. 

In all the examples given above, the importer, Lima and Company, 
has furnished funds with which to purchase a sterling or a dollar de- 
mand draft as cover for the draft drawn by the exporter. Lima and 
Company may, instead, resort to a purchase of cables, for by that 
means it is possible for the firm to save from twenty to twenty-five 
daysin time. If Lima and Company wishes to get an extension of time, 
permission must be secured from the Rio correspondent of the Chase 
National Bank to buy a cable instead of a draft. The importer pays 
an extra commission for this privilege and also a higher rate for cable 
exchange, because cables are always more expensive than drafts. If 
there is a possibility of a decline in exchange rates, it may be that the 
importer may secure a cable twenty days hence at about the same rate 
that a demand draft would have cost originally. 

As was noted above ! it is rather customary for exporters in certain 

1Cf. pp. 182-183. 


266 DOMESTIC AND FOREIGN EXCHANGE 


of the South American and Central American countries to pay their 
obligations in go day sight bank drafts. Before the World War these 
drafts were drawn almost exclusively on London; since that time, 
however, an ever increasing number has been drawn in dollars. Such 
drafts mature 90 days from the time that they are accepted by the 
bank upon which they have been drawn by the selling bank, and if 
they are sterling bills, three days grace additional must be allowed. 
In such cases, the draft of the exporter on the importer is drawn pay- 
able at “the bank’s drawing rate on the day of payment for go day 
sight drafts on London,” or in the case of dollar drafts, “on New York.” 
On the date that the draft of the exporter falls due, the importing 
firm has to hand the bank, that presented the original draft, sufficient 
funds with which to buy the “return draft” as specified. If the go 
day sight bank draft is drawn in sterling, it is forwarded to the New 
York bank that originally purchased the bill of exchange from the 
exporter. The New York bank either sells the draft in the New York 
market at the rate for 90 day sight bank drafts on London, and thus 
gets its money, or forwards it to London for acceptance and, very 
probably, for discount. The accepted draft will run for 93 days and 
will be paid at maturity. In the meantime the South American or 
Central American bank which sold the draft to the importer will put 
the accepting or paying bank in funds with which to meet the draft at 
maturity. It may do so by sending a sight draft or a cable, or by 
merely advising the London bank to deduct the amount of the draft 
from its (the selling bank’s) account. When the 90 day sight bank 
draft is drawn in dollars and sent to the New York bank, the latter pre- 
sents it to the American bank upon which it has been drawn, and 
upon acceptance the bill may be discounted in the New York market 
or held until maturity. 

When such go day sight bank drafts are to be used as “return drafts” 
it is possible for the importer to ask for a postponement of payment 
in order to obtain the temporary use of the funds; later he will pur- 
chase a sterling or dollar cable in order to reimburse the New York 
bank. It must be remembered that 90 day drafts are always worth 
less to the receiving bank than sight drafts, because of the delayed 
payment. Both yield the same number of dollars when paid at ma- 
turity, but with 90 day drafts the bank has to wait longer for its money 
and thus loses interest on the funds represented. . If it wishes to get 
the immediate use of the money tied up in the transaction and there- 


267 


IMPORT AND EXPORT CREDIT 


QSNL]JO JSIIOJUT YIM YeIq 


SL qanoly 





208 DOMESTIC AND FOREIGN EXCHANGE 


fore discounts the draft immediately upon acceptance, a sum smaller 
than the face value of the draft is realized. The bank appreciates 
these facts and takes them into consideration in fixing the amount 
for which it advises the exporter to draw his draft. A delayed payment 
necessitates that the exporter draw the draft for a larger amount than 
would be required were payment to be made by means of a sight 
draft. Thus the importer really pays for the privilege of enjoying the 
delayed payment, but, of course, he has a longer period in which to 
speculate on a fall in exchange rates on London or on New York. 

In all of the above instances of export credit transactions it is possible 
for the New York bank to instruct the foreign bank to accept funds 
from the importer and to credit them to the account of the New York 
bank, instead of bothering about remitting the exchange as called for 
in the wording of the exporter’s draft. It will ask that this procedure 
be followed if it is desirous of building up its foreign account for ex- 
change purposes or if it feels that more profit can be made by such an 
arrangement. 

Interest Clause. In the examples given above the interest charged 
by the bank has been figured in the amount for which the draft has 
been drawn. The practice in the trade with the Far East and also 
with the British West Indies is slightly different and requires that when 
the American bank purchases the draft and documents from the ex- 
porter it stamp on the face of the draft the so-called “interest clause” 
(Fig. 75), which varies in its wording as between banks. Some banks 
print the interest clause on the draft. The following are typical 
examples: 


“Payable at Bank’s selling rate for sight exchange on New York with 
interest at 8% per annum from date hereof until estimated date of arrival 
of return remittance in New York.” 


oe OL 


“Payable with exchange, commission, stamps and interest at 6% per 
annum from date hereof until estimated date of arrival of return remittance 
in New York.” 


or 


“Draft to be paid at current rate for Bank demand draft at date of pay- 
ment with interest added at 9% per annum from date to approximate date 
of returns reaching London,” 


IMPORT AND EXPORT CREDITS 269 


or 


“Payable in United States gold coin or its equivalent together with 
interest at the rate of 9 per cent per annum from date hereof until approxi- 
mate date of repayment in San Francisco and all collection charges.” 


The foreign correspondent that presents the bill for acceptance and 
which later collects its value from the importing firm also computes 
the interest and commissions that must be paid. It knows the ap- 
proximate or customarily accepted number of days required for the 
original draft to arrive from the purchasing bank and for the remit- 
tance to be returned to that bank. It also knows the usance of the 
bill, and is therefore able to calculate at the designated rate the amount 
of interest that will have to be paid by the importer. This sum will be 
added to the face value of the original draft, and will determine the 
amount of exchange that the importer must purchase for remittance. 
If the clause states that the draft is payable at “the bank’s selling rate” 
for the kind of exchange designated in the interest clause, then the 
importer is compelled to purchase such exchange from the bank holding 
the accepted draft. If that phrase is absent, the importer is free to go 
to any bank, procure the required exchange at the best obtainable 
rate, and turn it over to the correspondent bank to be remitted to the 
payee bank. 

The commission of the foreign bank depends upon “local custom and 
the degree of accessibility or inaccessibility of the point where the 
collection is made.” + It will be noted that several of the interest 
clauses mentioned above do not contain any reference to commissions 
or who shall pay them. The reason is that the rate of interest, which 
is generally high, is intended to cover the usual commissions. Stamp 
taxes are also passed on to the importer. 

The rate of interest varies from time to time, but is customarily 
fixed for the United States by the rate quoted in the New York ex- 
change market, which in its turn follows closely the rate charged by 
the London market. Exchange dealers state that a small group of the 
large banks in New York fix the interest rate used in such transactions. 

Hough in his excellent volume “ Practical Exporting,” in discussing 
the insertion of the interest clause, concludes that “There is an element — 
of great uncertainty about it, and a great many foreign houses object 
to this practice, in fact object to paying more than the charges specifi- 


‘Irving National Bank, “‘Trading with the Far East,” p. or. 


279 DOMESTIC AND FOREIGN. EXCHANGE 


cally named by invoices. The clause in question, therefore, should 
not be included except by previous agreement with the customers.” ? 
Exporters are urged by bankers to draw their drafts for an amount 
that will include interest charges, commission, stamps, etc., because 
importers, especially those in South America, refuse at times to pay 
more than the face value of the draft. In Argentina a banker cannot 
legally collect more than the face value of the draft. In the Scandina- 
vian countries, notations relating to the payment of interest and other 
charges may be placed on the bill of exchange, but they are without 
legal effect, the drawer being under no legal obligation to pay them. 
It should also be noted that in the Scandinavian countries if drafts 
are to be paid at the ‘“bank’s selling rate,” banks are not permitted 
to apply their own rates, but are legally compelled to use the official 
rates published by the Stock Exchange Committee of their respective 
countries. 

Colonial Clause. Another clause requently met with is the “colonial 
clause”? appearing only on drafts drawn against South African and 
Australasian merchants and issued against exports to them. It is 
never used on drafts drawn on other countries and seldom on drafts 
drawn on banks in the two countries mentioned. This clause may 
read, ‘Payable with exchange and Eng sh Colonial stamps at the 
current rate for negotiating this in London on the colonies,” or “ Pay- 
able with exchange (English and Colonial stamps added) at the current 
rate in London for negotiating bills on the Colonies” * (Fig. 76). 
The importer, i. e., the drawee, is by this clause compelled to pay all 
charges for English and Colonial stamps, collection fees, interest from 
the time the draft is drawn until the date of arrival of the proceeds 
in London, the difference in exchange rates, etc., so “that the bank 
that finally presents the draft for payment, collects from the drawee 
not only the face value, but also all these accrued charges.” * South 
Africa and the Australasian colonies have the same sovereign for their 
unit of value as has England. The rate of exchange in London on 


iP. 403: 

2 Cf. Whitaker, op. cit., pp. 310-318 for the best available discussion of this clause. 

3 “Bills upon South Africa or Australasia originating in England do not customarily 
bear the colonial clause. But a substitution for the clause is in constant use by English 
drawers. Instead of enfacing the latter on their bills they simply add the ‘exchange’ to 
their invoices, and reach the same result. Thus if £100 is due the English exporter, he 
adds the £2 for exchange to the invoice and (disregarding stamps) draws an ordinary bill 
for £102.” Whitaker, op. cit., p. 317. 

4 “Selling in Foreign Markets,” compiled by G. E. Snider, U. S. Bureau of Foreign poe 
Domestic Commerce, Miscellaneous, Series No. 81, p. 548. 


271 


IMPORT AND EXPORT CREDITS 


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12 18 admeye TeTno 





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272 DOMESTIC AND FOREIGN EXCHANGE 


these countries, however, varies just as does the rate of exchange 
between the United States and Canada which have the same “dollar” 
for their standard of value, or as the rates of domestic exchange be- 
tween New York and San Francisco formerly fluctuated before the 
introduction of the Federal Reserve System. A draft bearing the 
Colonial clause is payable by the drawee in the pound sterling of his 
own country, not in the pound sterling of London. It is not the rate 
of exchange on London in the drawee’s country that determines what 
the drawee shall pay: it is the rate of exchange zm London on the 
drawee’s country on the date of maturity of the draft that fixes the 
cost of the draft to him. Furthermore, it is the rate zz London on 
that date for bills of the same usance, not for sight bills or for tele- 
graphic transfers. It will be noted by reference to the wording of the 
Colonial clause that it requires that the bill be payable “at the current 
rate” (meaning the rate existing on the date that the drawee pays the 
draft), “for negotiating this 7x London” (meaning the rate at which 
a bill of the same type, same usance, etc., would be negotiated in 
London on the same day that the draft becomes payable by the 
drawee). 

To illustrate a case where the colonial clause is used, say that the 
San Francisco Exporting Company sells goods valued at $48,600 to 
the Australian Importing Company of Melbourne. If the sight rate 
on London on the day the draft is drawn stands at 4.86, the exporter 
will draw against the Australian firm for £10,000, regardless of whether 
the usance of the draft be sight, 30, 60 or 90 days. The exporter 
draws always at the prevailing sight rate on London. The Colonial 
clause is stamped on the face of the draft, which is thereupon sold, 
along with the documents, usually to a branch of an English or Colonial 
bank. The draft is sold at par, sometimes at a premium, because 
when the draft is finally paid by the importer it will yield a sum that 
is above par for reasons that will be later explained. “It is not neces- 
sary for the shipper to concern himself with a calculation of the ap- 
proximate time that will elapse before his draft is presented, the time 
it has to run, and the time required for the return of funds, and to add 
interest for all this time to his invoice or provide for it in his price, nor 
need he be concerned regarding fluctuations of exchange. He has only 
to convert his invoice from dollars into pounds sterling at the sight 
rate on London and draw his draft for the resultant amount. This 
draft can be sold to any bank having the proper London and Aus- 


IMPORT AND EXPORT CREDITS 273 


tralian connections for full face value. The transaction is to all 
intents and purposes a cash one for the manufacturer or shipper, al- 
though, of course, he still runs the credit risk, as such drafts are not 
bought ‘without recourse’ unless a confirmed banker’s credit has been 
opened. In the case of sight drafts this risk is reduced to a minimum, 
since the drawee cannot obtain possession of the corresponding goods 
until the draft is paid. In other or doubtful cases it is not difficult 
for the manufacturer to satisfy himself of the standing or reputation 
of the client through the reliable commercial agencies that have 
branches in Australia or through the correspondents of the Australian 
banks.” ! 

The draft and documents are forwarded to the importer through a 
Melbourne bank, the draft is accepted by him, and runs, say, for go 
days. At maturity, the importer comes in and pays the bank the face 
value of the draft and the accrued charges, plus the premium that is 
being charged zm London on that date for go day bills on Melbourne. 
Exchange rates in London on Australia (and also on South Africa) 
normally stand at a premium,” the amount of the premium varying 
from day to day, so that the bank that has purchased a draft bearing 
the Colonial clause is always certain of receiving more than the amount 
for which the draft has been drawn. American banks always ask 
Australian banks to remit directly to London because sterling ex- 
change is cheaper than dollar exchange. Australian banks have 
accounts in London and are able to draw drafts on their accounts 
when remitting to the London accounts of the American banks.’ 
The practice is for the Australian banks to forward the original draft 
to the designated London bank and the duplicate draft to the American 
bank. 

Writing on “Exporting to Australia,” * Mr. Philip B. Kennedy in 
1916 stated that: 


“Since the war a fair number of drafts have been drawn in dollars and 
sent to the Australian banks for collection. If the drawer wishes to realize 
the face amount of the draft, this should be provided for by a clause stamped 


1Commercial Attaché W. C. Downs of Melbourne in “Export Trade Suggestions,” 
Miscellaneous Series No. 35, U. S. Bureau of Foreign and Domestic Commerce, p. 53. 

2It was not at a premium in 1921. 

3 American banks do not have branches or accounts in Australia. The Australian banker 
has maintained a closed monopoly of banking in his country. 

4 Miscellaneous Series No. 45, U. S. Bureau of Foreign and Domestic Commerce, pp. 
15-16. 


274 DOMESTIC AND FOREIGN EXCHANGE 


on the draft. The Bank of New South Wales, which does more of this col- 
lection than any other Australian bank, advises that the following clause 
should be added to enable them to remit the face amount in dollars: 


‘To be converted into sterling at the Bank of New 
South Wales rate on due date, and payable at the current 
rate of exchange for purchasing demand drafts on London 
with all charges.’ 


“At this date (June 28, 1916) the Bank of New South Wales will convert 
at the rate of $4.75. This rate is on collections forwarded by an American 
bank. Exchange at 1 1/4 per cent is added, together with 3/8 per cent com- 
mission. If a draft of a face value of $475 had been sent forward for col- 
lection with this clause added, the importer would be called upon to pay 
the following amount: 





S475 Dol 7S 2h he eee £100 os. od. 
PXCUAUNRE. 2 ssa: sole ee I 5. 10 
COMMISSION): % 5... 2. Bee ee 
Duty stamp !>. U.. eae eee paler 
‘Total: 2.00.2 6. a a ee ae Oe ce 


“Tf the terms of the sale were on the basis of draft against date drawn 
in New York, the Australian bank may also be asked to add interest for 
the time taken for the round-trip mail, which is usually reckoned at 72 
days. The rate of interest is 6 per cent, and in this case the a a 
would also be asked to pay 72 days’ interest at 6 per cent. 

“The Bank of New South Wales, the largest bank in Australia, will 
now forward a draft upon the National City Bank of New York, where an 
account is kept, for the full amount in dollars up to £1,000. For larger 
amounts the sum will be forwarded to be converted at the New York sight 
rate on London. This limit on dollar exchange is due to the difficulty that 
the Australian bank may have in replenishing its funds in New York. It 
is not policy to carry large accounts in New York, because New York 
banks pay only 2 per cent interest on bank accounts, whereas at present 
4% per cent is being paid in London for similar accounts. 

“The advantage of adding the colonial clause to the draft is that the 
full amount may be obtained at once. The London banks that accept and 
carry these bills finance the time consumed. 

“Tt is probably fully as cheap for the importer at present to have drafts 
drawn upon him directly in dollars, because the Australian exchange on 
London is now much higher than normal, 214 per cent. Drafts drawn in 
dollars with the above mentioned clause attached and forwarded direct 
are entirely feasible at the present time.” 


IMPORT AND EXPORT CREDITS 275 


Exchange as per Indorsement. Another practice, again peculiar to 
the English exporter, is the drawing of drafts bearing the clause “ Ex- 
change as per indorsement”’ or “At the rate of exchange as per first 
London indorsement.” This makes the bill drawn by the English 
exporter in sterling eventually payable in a foreign currency at a pre- 
determined rate for each pound sterling. Thus if an English merchant 
draws a go day draft for £1,000, on a New York firm, and includes 
the clause “Exchange as per indorsement,” the London banker who 
negotiates the bill will pay the exporter the face value of the draft 
less the usual commission and charges, will then convert the sterling 
into dollars at the 90 day rate on New York and will indorse on the 
bill either the total amount of dollars to be paid by the importer or 
the rate of sterling exchange at which payment is to be made. The 
object of the drawer is to avoid the risk of loss in exchange and at the 
same time to satisfy the drawee that the rate of conversion has been 
fixed by an impartial referee, viz., the bank. Previously it was cus- 
tomary for the banker to indorse the rate of conversion on the draft 
(note that the clause says “rate as per indorsement’’) but “owing to 
the increased number of cases in which the persons on whom bills of 
exchange are drawn refuse to pay the equivalent at the rate of exchange 
indorsed on the bills, the custom among some of the bankers is to 
quote the seller the rate and insist on his indorsing it on the bill him- 
self. Under this arrangement any dispute which may subsequently 
arise when the bill is presented can be referred back to the drawer for 
settlement between the drawee and himself.” ! 

Domiciled Bills. A variation of the documentary bill drawn under 
a commercial letter of credit and drawn in one country on a second 
but payable in a third country, either in the money of the second or 
in the money of the third, is found in the “domiciled bills,” known 
for short as “domiciles.”’ Suppose that an American exporter draws 
a bill on a French bank covering shipments of cotton to a French firm. 
The French bank accepts the draft, and by the wording of its accept- 
ance makes it payable at a certain bank in London. The bank that 
presented it for acceptance then forwards it to London to its corre- 
spondent either for discount or to be held until maturity. The draft 
therefore becomes “domiciled”? in London. A short time before it 
falls due, the French accepting bank forwards funds to the London 


1 Spalding, Foreign Exchange and Foreign Bills,” (1st ed.) p. 141. Cf. Bankers’ Maga- 
gine, (England), January, 1921, pp. 65-60. 


276 DOMESTIC AND FOREIGN EXCHANGE 


bank that is to pay the draft, and with these funds payment is made 
at maturity. All charges, of course, are met by the French importing 
firm. The London discount market harbors a very great prejudice 
against domiciled bills and charges a higher rate of discount, usually 
a quarter to one half per cent per annum higher than for bills bearing 
the acceptance of a British bank. The bill must bear two stamps, 
one for the accepting country and one for England. These facts are 
taken into consideration in the New York market when the bill is 
offered for sale, and as a consequence a bill that is to become a domicile 
commands the lowest price for documentary bills of the same usance. 
Another matter that similarly affects the price of the bill is that it is 
sent by an indirect route to London, taking much longer than if it 
were forwarded directly to London from New York. The New York 
bank is out of funds for the additional time, not being able to have the 
draft discounted until it reaches London, and therefore has to charge 
for the loss of time. “ Partly because of these disadvantages attaching 
to the domiciled bill, some foreign banks in their eagerness to retain 
the financing of native imports by means of sterling bills, have estab- 
lished branches in London for the purpose of giving their bills the status 
of London acceptances. But London bill buyers show some discrimi- 
nation even against the sterling bills of these foreign agencies. As a 
rule they reserve the lowest discount rate for bills of purely British 
acceptors, the great joint-stock banks, and the world-renowned private 
banking firms, whose business is primarily that of accepting bills.’’ * 

The attitude of the discount market in the United States toward 
domicile bills closely follows that of London. During the spring of 
1920 a plan was submitted to the Federal Reserve Board in connection 
with a proposed method of financing cotton shipments whereby the 
American exporters would draw six months drafts on foreign spinners, . 
not on banks; the spinners after accepting the drafts were to present 
them to their local banks for indorsement, giving a chattel mortgage 
on the cotton as security. These drafts were to be made payable in 
the United States. The question arose as to whether or not such bills 
could be discounted at the Federal Reserve banks. The General 
Counsel of the Federal Reserve Board ruled that “Although a draft 
drawn by an American exporter upon a foreign buyer and accepted by 
that buyer payable in the United States in dollars may be technically 
eligible for discount under the terms of section 13 of the Federal Re- 

1 York, op. cit. p. 142. 


IMPORT AND EXPORT CREDITS 277 


serve Act, nevertheless, a Federal Reserve bank may, in its discretion, 
decline to discount such an acceptance on the ground that, inasmuch 
as it is a domicile bill, it is not a desirable investment.’’ The Federal 
Reserve Bulletin of April, 1920, in commenting upon this ruling added 
that “The Federal Reserve Banks have evidenced their unwillingness 
to discount acceptances made by foreign banks payable in this country 
in dollars unless the accepting bank has an office and assets in this 
country. It is also understood that most of the central banks of 
Europe have generally declined to afford a market for bills of this 
character. With the foreign exchange market in its present unsettled 
condition the principles which make domicile bills undesirable even 
in normal times are now all the more pertinent.” ! 


As it is possible for local banks which do not have an international 
reputation to arrange through other bankers for the sale of certain 
kinds of exchange, as has been described, so it is also possible for them 
to arrange for the issuance of letters of credit through their corre- 
spondents located in either domestic or foreign commercial centers. 
In this connection as in all others, state laws govern state banks and 
national laws govern national banks. So far as I know there has been 
no question raised regarding the powers of state banks to make such 
arrangements, but lately (May, 1921) the Federal Reserve Board 
has handed down a significant ruling affecting the manner in which 
national banks have been accustomed to issue letters of credit to their 
clients. It has been rather customary for an interior bank to have 
its large city correspondent issue the letter for the customer’s account 
which letter the interior bank would guarantee, i. e., if the client 
should fail to put the issuing bank in funds with which to meet the 
drafts at maturity, the interior bank guaranteed that it would do so. 
The Federal Reserve Board has ruled that a national bank does not 
have the right to act as surety on a letter of credit issued by another 
bank; that, while it itself has the right to issue a commercial letter of 
credit and to accept drafts drawn under such letters of credit, never- 
theless “such powers do not carry with them the power to guarantee, 
or act as surety upon, acceptances or letters of credit issued by other 
banks.” The Board, however, has outlined a plan whereby an interior 
bank may still have its large city correspondent issue letters of credit 
for local customers without running contrary to the Board’s ruling. 

1P. 386, 


278 DOMESTIC AND FOREIGN EXCHANGE 


It is proposed that the interior bank merely designate the city corre- 
spondent as the agent which is authorized to issue letters of credit 
to customers of the former. The interior bank’s name will not appear 
- on the letter of credit, but the city correspondent is to look directly 
and unconditionally to it for reimbursement, and not conditionally 
upon the failure of the client to put the issuing bank in funds. Under 
this arrangement the client will pay the sum involved to the interior 
bank, and the latter will reimburse the city correspondent. To the 
layman this new arrangement seems to be merely a case of “beating 
the devil around the bush,” but, in so far as banking law is concerned, 
it really represents an entirely new and also a legal practice. And, 
while, at first sight, the decision appeared to many to mean the cur- 
tailment of the activities of national banks in the financing of foreign 
trade through letters of credit, the new plan as suggested by the 
Board points to a thoroughly satisfactory and legal way out of the 
difficulty. 

Collecting Drafts Abroad. It is not an uncommon practice for ex- 
porters to hand their drafts and documents to their local banks for 
collection rather than to offer them for discount. It may be that 
discount rates are unsatisfactory and that the exporter has sufficient 
funds to carry him until the collections are made; or possibly the 
consignee is unknown and the shipper is not quite certain as to whether 
or not the draft will be accepted, thus possibly involving extra ex- 
pense in the shape of protest fees, etc.; or the shipper may have agreed 
that the consignee is to take the merchandise in part lots, making 
pro-rata payments therefor, thus having returns forwarded to him 
by the collecting bank as each separate lot is delivered. 

If the collection method is adopted, the shipper should be careful to 
draw his draft in such a way that he will be sure to receive its full face 
value. The directions given by the American Express Company in 
this connection, which may advisedly be followed in all cases, are as 
follows: 


“Drafts to be collected by the American Express Company should be 
drawn to shippers’ own order, and indorsed to the American Express Co. 

“Tf full face value of dollar drafts is desired, each draft should carry the 
following: ‘Payable with exchange, all bill stamps and all collection charges 
at holding bank’s selling rate of exchange for sight drafts on New York.’ 

“Tf full face value of drafts, plus interest is desired, each draft should 
carry the following: 


IMPORT AND EXPORT CREDITS 279 


““Payable with exchange, all bill stamps and all collection charges plus 
interest at the rate of 6 per cent per annum from date of issue to approxi- 
mate due date of arrival of cover in New York.’ 

“Tf collection charges are for account of drawer, the dollar draft should 
bear the following phrase: ‘Payable at the collection bank’s selling rate 
on day of payment for sight drafts on New York.’ 

“Tn drawing upon Spain and France, the check form instead of the draft 
form should be used (on account of resulting economy of bill stamps), in 
other words the phrases referring to the words ‘exchange’ and ‘value re- 
ceived’ should be omitted on the face of the draft. Dates and amounts 
must be written in words instead of figures.’’! 


Detailed instructions relating to every possible contingency should 
accompany the bill of exchange. Are the documents to go D/A or 
D/P; what is to be done in case or non-acceptance or non-payment; 
shall the draft be protested; these and similar questions should be 
completely covered by the instructions. If the bank is advised before- 
hand concerning these matters it is then in a satisfactory position to 
care for the interests of the shipper. Furthermore, the bank is “on 
the ground,” so to speak, and can care for emergencies as they arise. 
At times the importer for sundry reasons may be unable to accept 
the draft. The shipper, being informed by the collecting bank of that 
fact, may order the latter, if possible, to clear the goods pending 
their resale to another party. This type of service rendered by the col- 
lecting bank “is of great importance in many South American coun- 
tries, where clearance must be effected within a limited time after 
the arrival of the shipment, or else heavy penalties are incurred. Or, 
if non-payment is due to temporary financial difficulties of the pur- 
chaser, the collecting bank, upon receipt of new authority, is in position 
to obtain full satisfaction by using the installment plan. Allowing 
payment of one-third of the draft in 30, 60 or go days has been suc- 
cessfully applied in cases which have appeared to be hopeless at first. 
Or again, if the shipment is valuable, instructions may be given to 
reforward it to another nearby market or even to return it to the 
United States.” ” 

There is always the question as to who is to pay the collection 
charges. These are nominal sums and are levied at a graduated scale 
upon the face value of the draft. European banks charge from 1/16 


1 Foreign Trade Bulletin of the American Express Company, July-August, 1919. 
2 Ibid, October-November, 1917. 


280 DOMESTIC AND FOREIGN EXCHANGE 


to 1/8 of one per cent. The fees of the American banks are slightly 
higher. The seller and buyer usually agree beforehand as to which 
party is to pay the collection charges. “In the absence of any previous 
agreement as to the payment of such charges, exporters should remem- 
ber that the laws of many foreign countries, particularly in South 
America, make it impossible for the banker to collect more than the 
amount for which the bill is drawn. Quite frequently the above clause 
[relating to collection charges] is used without the consent of the pur- 
chaser, and the collecting bank has the alternative of declining to 
receive payment altogether or of waiving all claim to the charges. 
If they are waived, the banker does so because he believes it to be 
against the exporter’s interest to refuse the face amount of the draft 
and naturally will look to the exporter to refund him for his services 
to the extent that he was entitled to collect from the drawee.” ! 

Export Credits. There are still other ways by means of which inter- 
national trade may be financed. For example, the importer may go 
to his local bank and arrange to open an account with a bank in the 
exporter’s country. He can deposit funds with his local bank, which 
will then forward exchange or by other means open an account for him 
with the designated foreign bank. Instructions will also be forwarded 
at the same time asking the foreign bank to receive the documents 
and to pay the sight draft of the exporter when presented by the 
latter. The exporter is notified by the bank with which the account 
has been opened. The exporter prepares his documents and draws 
his draft on the local bank. The bank cashes the draft and forwards 
the documents to the correspondent bank in the importer’s country. 
The latter bank then turns the documents over to the importer and 
he gets the goods. Both the bank in the exporter’s country and the 
one in the importer’s country will charge a small commission to the 
importer for acting in the above capacity., One advantage of this 
method is that the importer is saved the risk of forwarding cash with 
his order.?, No money is paid out by the foreign bank until the ship- 
ment has actually taken place. The importer, however, loses interest 
on the funds involved. 

Another practice followed at times is to have the importer arrange 
to have his bank instruct its foreign correspondent to pay out a speci- 
fied sum of money to the exporter under certain designated conditions 


1 Foreign Trade Bulletin of the American Express Company, October-November, 1917. 
2 Cis p23. 


IMPORT AND EXPORT CREDITS 281 


and to charge the same to its (the importer’s bank’s) account. The 
importer then has to pay the commission of the foreign bank and also 
of his own bank plus interest on the use of the money, but these 
charges generally compare favorably with what he would have to 


Irving National Bank 


> 











New York, January 7; 1919 





Irrevocable Export Credit No. 627 Expiring June 30,1919 


Yew York Motor Company, 
New York City. 


Centlemen:- 







You are hereby authorized to draw upon us at + * + = « Sight ~ sce 


for accountof Java Motor Company -+-+-+-++e#-+-++-++++-+2s2- cee oe 










to the extent of FOUR THOUSAND AND 00/100 DOLLARS ($4000,00) --..-.. 
covering nine (9) motors to be shipped to the Dutoh East Indies 





Documents (Complete sets unless otherwise stated) comprising: 
Steamer 
Bills of Lading issued to order of consignee 


ex 


Invoices 





Insurance Policies covering marine and war risk 


to be delivered to us against payment 











Insurance 4S above. 





Bills of Lading issued by Forwarding Agents will not be accepted unless specifi- 
cally authorized ‘herein, and any modifications of the terms of the credit must be in 
writing over authorized signatures of this Bank. 

Drawings must clearly specify the numbér of this Credit. 


Yours very truly, 


Ratered PRO FORMA 
Vice-President. 






FIGURE 77 
Confirmed export credit 


pay for sight drafts should he choose that method of paying the ex- 
porter. 

Somewhat similar is the method whereby the importer arranges 
with his bank for the establishment of a credit ' in the exporter’s 
country. A great deal of Asiatic trade with the United States is 


1The term “letter” is seldom employed in connection with export credits such as are 
described in the following pages. The terms ‘‘export credit,” “credits” or “advice of 


282 


DOMESTIC AND FOREIGN EXCHANGE 


financed in this manner. Such credits may be established in one of 


several ways. 


The importer, say the Java Motor Company of 


Batavia, may ask the Netherlands State Bank to issue an “export 








Export Credit No. 600 Expiring June 30,1919 
New York Motor Company, 


Gentlemen: 


accountof - - Java Motor Company == at +--+ = sight --.«-... 
to the extentof FOUR THOUSAND AND 00/100 DOLLARS ($4000.00) +--+ ©. . 
covering nine (9) motors to be shipped to the Dutch East Indies. 


Documents {Complete sets unless otherwise stated) comprising: 
teamer 

ills of Lading issued to order of consignee 
Invoices 


Insurance Policies covering marine ané@ war risk. 


to be delivered to us against payment 
[surance a8 above, 
This letter is for your guidance in preparing documents and conveys no engage 
ment on the part of this Bank as we have 10 instructions to confirm the Credit. 

Bills of Lading issued by Forwarding Agents will not be accepted unless specifically 
authorized herein, and any modifications of the terms of the credit must be in writing over 
authorized signatures of this Bank. 

Drawings must clearly specify the number of this Credit. 


Irving National Bank 


> 





New York, January 7, 1919 















New York City. 











We are informed that you will draw upon us for 






















Yours yery truly, 


PRO FORMA 








Vice-President. 


FIGURE 78 
An unconfirmed export credit 


credit’! on its New York correspondent in fayor of the New York 
Motor Company, covering the shipment of nine motor cars. The 
Java Motor Company then fills out and signs a letter of guarantee, 


credit” are, however, generally used. The reason probably is because the banks in the ex- 
porters’ country that advise the exporters of the existence of such credits do not assume 
any primary obligations, but rather secondary obligations contingent only upon the default 
of their correspondents abroad. Cf. Federal Reserve Bulletin, April, 1921, p. 413. 

! When an English bank establishes for its client a credit in a foreign country and in the 
money of that country, it is called a “currency credit.” 


IMPORT AND EXPORT CREDITS 283 


similar to the one discussed above in connection with commercial 
letters of credit.1 The Java bank then notifies the Irving National 
Bank, its New York correspondent, and asks it to act in the desired 
capacity. The Irving National Bank sends to the New York Motor 
Company either a confirmed (Fig. 77) or an unconfirmed export letter 
of credit (Fig. 78). This form notifies the exporter that he is to draw 
upon the Irving National Bank at sight or at so many days sight 
for goods to be sent to-the Java Motor Company. If the draft is 
drawn at sight the Irving National Bank will pay when it is presented 
with documents attached, provided the terms of the credit have been 
complied with. It may pay directly out of its own funds, or it may 
instead be advised to debit the account of the Netherlands State 
Bank which it holds. The Irving National Bank forwards the docu- 
ments to the Netherlands State Bank, accompanied by a statement 
of its charges. If it pays the draft from its own funds the charges will 
include the face value of the draft, the bank’s commission, and also 
interest on the funds invested from the time the draft has been paid 
until a remittance can reach it from the Netherlands State Bank. 
On the other hand, if it simply debits the account of the Java bank 
for the transaction, the charges cover only its commission for acting 
as the representative of the Java bank. All charges are finally passed 
on to the importer in accordance with the terms of the letter of guar- 
antee which he signed at the time he asked that the export credit be 
opened for him. 

If the draft is for go days sight the Irving National Bank accepts 
the draft and returns it to the exporter, takes the documents and for- 
wards them to the Netherlands State Bank, notifying it at the same 
time of the due date of the draft. The Java bank collects the funds 
from the Java Motor Company in time to forward them to the Irving 
National Bank so that the latter bank may be put in funds wherewith 
to meet the payment of the draft at maturity. The exporter may 
either hold the accepted draft until maturity or he may have it dis- 
counted immediately in the New York open market. The accepting 
bank may discount its own acceptance, thus making it unneces- 
sary for the exporter to discount it elsewhere, but this is not gen- 
erally done. When it is, however, the draft may be canceled as 
paid, or it may even be sold to some other bank and later paid at 
maturity. 


3 Pp. 238-239... 


284 DOMESTIC AND FOREIGN EXCHANGE 


It should be evident, from our discussion in this chapter, that 
bank credits of all kinds used to finance foreign trade may be grouped 
into irrevocable, revocable, confirmed, and unconfirmed. Whena bank 
issues a letter of credit on itself the letter may be revocable or irrevo- 
cable, depending upon whether or not it reserves the right to rescind 
its engagement to honor drafts drawn on it by the beneficiary.!_ When 
it issues a letter of credit on a foreign bank and asks it to notify the 
beneficiary that it (the foreign bank) agrees to honor the drafts drawn 
on it, or where the beneficiary asks the foreign drawee bank to give 
such a guarantee and the foreign bank does so, the letter of credit then 
becomes a “confirmed” credit. If such a guarantee is not asked for, 
or if it is asked for and not given, it is known as an “unconfirmed” 
credit. There has been much confusion in the use of these terms both 
by bankers and by traders. The statements of Mr. George W. Ed- 
wards in the Federal Reserve Bulletin of February and June, 1921, 
are so excellent and so authoritative that I take the liberty of quoting 
them verbatim. 


“Tf the credit-issuing bank reserves the right to withdraw from the 
undertaking, the document is styled a ‘revocable’ letter of credit. The 
‘irrevocable’ letter of credit contains a definite engagement on the part 
of the issuing bank to honor drafts drawn by the beneficiary in accordance 
with the terms and conditions specified in the letter. This engagement 
may not be canceled by the issuing bank prior to the expiration date with- 
out the consent of the beneficiary. The ‘irrevocable’ letter of credit may 
be strengthened further by having the notifying bank in the same country 
as the exporter add its unqualified assurance that it will pay or accept the 
bills drawn by him even if the foreign bank should refuse to honor them. 
It is then called a ‘confirmed export letter of credit. Expressing, there- 
fore, both the definite undertaking of the issuer and also of the notifier, 
it is actually an ‘irrevocable-confirmed’ letter of credit. Where the notify- 
ing bank does not add its guaranty, the credit is described as ‘unconfirmed,’ 
since the advising bank maintains that it is merely transmitting the informa- 
tion of the credit to the beneficiary without incurring liability for its con- 
tinuance. Thus three classes of letters of credit may exist: (1) Irrevocable 
by the issuer and confirmed by the adviser; (2) irrevocable by the issuer 
but unconfirmed by the adviser; (3) revocable by the issuer and also un- 
confirmed by the adviser.”’ 2 


1 The beneficiary is always the party who is authorized to draw drafts under the terms 
of a letter of credit. 
2 Federal Reserve Bulletin, February, 1921, p. 158. 


IMPORT AND EXPORT CREDITS 285 


“Ttis . . . clear that a distinction must be drawn between an irrevocable 
and a confirmed letter of credit. The irrevocable letter of credit is a docu- 
ment in which a foreign bank promises to honor the drafts of the bene- 
ficiary, provided he complies with certain conditions stated in the letter, 
and it is an obligation absolutely binding upon the issuing institution. 
This credit may be sent directly by mail to the exporter, or it may be trans- 
mitted by cable to a correspondent bank, which in turn informs the favored 
party of the credit. This report is conveyed without the assumption of 
any liability by the informing bank. However, if the notifier, at the re- 
quest of the issuer, adds its guarantee or confirmation to the advice ad- 
dressed to the beneficiary, it then becomes an engagement binding upon 
both banks. In other words, one credit is irrevocable by the issuer but 
unconfirmed by the notifier, and the other is both irrevocable by the issuer 
and further confirmed by the notifier.” 1 


Most bank credits are irrevocable and not confirmed. Some are 
irrevocable and also confirmed. A very small number are revocable 
because an exporter does not care to ship goods under the terms of a 
revocable letter of credit. 

Regarding the type that is revocable by the issuer and unconfirmed 
by the notifier, Mr. Edwards states that this form “ does not constitute 
a true letter of credit, for the document is the obligation neither of the 
issuing nor of the notifying bank, and hence cannot be described as a 
‘credit.’ This document should be termed rather a ‘letter of advice.’ 
It serves a definite trade purpose especially in financing shipments 
from agents, affiliated concerns or firms which, of course, would not 
cancel their obligations. Most banks do not issue these revocable 
letters of advice.” ” 

The above classification “is a departure from the usual precept 
that the terms ‘confirmed’ and ‘irrevocable’ are synonymous as 
applied to commercial credits. However, while writings on this sub- 
ject accept the two-fold grouping of confirmed or irrevocable as against 
unconfirmed or revocable credits, actual banking practice operates 
on the classification given above.” ® 

While it may be said that the exporter is normally protected against 
loss by an irrevocable letter of credit, nevertheless it is always advis- 
able for him to examine most carefully the phrases and clauses, terms 
and conditions which the letter contains. A letter of credit will lapse 

1 Federal Reserve Bulletin, June, 1921, p. 683. 


2 Ibid, p. 683. 
3 Ibid, February, 1921, p. 158. 


286 DOMESTIC AND FOREIGN EXCHANGE 


if not availed of within the designated time; or it may contain a 
“joker”? of some sort, hidden away in a mass of verbiage, that may 
make it impossible for the exporter to realize on it regardless of how 
closely he lives up to its terms; or it may be so worded that errors, 
and subsequently disputes and legal proceedings, may easily arise if 
the exporter does not study and understand its various parts. The 
beneficiary must ever be on his guard, and should remember, as some- 
one has well said, that ‘‘A letter of credit is just as safe as its wording.” 
A situation similar to those that exporters have to meet from time to 
time is illustrated by the following: An American exporter received 
a letter of credit from an Oriental importing firm, the letter containing 
a clause to the effect that “Shipments are to be made as per buyer’s 
shipping instructions.” No additional instructions were given as to 
shipping dates. The goods were awaiting shipment in August, the 
letter was to expire in October, but prices fell greatly in the meantime 
and the importer took advantage of the loophole, refused to give ship- 
ping instructions and thus canceled his engagement. Such clauses 
enable an unscrupulous importer to assure himself of a supply of goods, 
and if prices fall or if he can obtain better terms from some other ex- 
porter, he can simply allow the credit to expire by refusing to forward 
the necessary shipping instructions. 

Statements similar to the following appear in irrevocable letters of 
credit: 


“We hereby agree with the drawers, indorsers and bona fide holders of 
drafts drawn under and in compliance with the terms of this credit that 
the same shall be duly honored upon presentation to us.” 


or 


“We hereby engage that drafts in compliance with the terms of this 
credit will be duly honored.” 


or 


“We engage that the bills so drawn shall be accepted on presentation 
and paid at maturity.’’ 


Banks may confirm credits by stating that: 
“We herewith open a confirmed credit in your favor.” 
or 


“We are informed hv--------— (the issuing bank) that they 


IMPORT AND EXPORT CREDITS 287 


have established a credit with us in your favor, which we herewith con- 
frm?’ 


or 





“We hereby confirm the following credit opened at the request of 
(the issuing bank).” 
Bank credits that are revocable contain statements similar to the 
following: 


“This credit is revocable and subject to cancellation.” 


or 


“Please note that this credit may be modified or canceled with or with- 
out notice to you.” 


Banks may refuse to confirm credits by using such statements as 
the following: 


“Please note that this is an unconfirmed credit.” 


or 


“We have no authority from our clients to confirm this credit.” 


Legal Aspects of Commercial Letters of Credit. During the last half- 
century the commercial letter of credit in one form or another has 
been the financial basis for the development of the greater part of the 
foreign trade of England. Questions have arisen from time to time 
as to the rights of exporters, importers, issuers, and negotiators, and a 
line of decisions has been handed down by the British courts. With 
the United States, however, it has been only since 1916 that the 
commercial letter of credit issued by American banks in terms of 
dollars has played even a small part in our foreign trade. When prices 
were rising and while trade was booming, almost no questions arose 
among American bankers and traders as to the rights of the parties 
under letters of credit. But when in 1920 prices began to tumble in an 
incredible manner, and importers found themselves held to pay for 
goods contracted for at higher prices, and facing losses of considerable 
magnitude, they hastened by every conceivable device to attempt 
the cancellation of their contracts and to avoid fulfilling the terms of 
confirmed letters of credit which banks had issued at their request. 
Not only did cancellation of contracts become a common practice 
among our own merchants and importers, but American exporters 


288 DOMESTIC AND FOREIGN EXCHANGE 


also found that foreign merchants likewise availed themselves of every 
excuse and form of trickery for the purpose of avoiding their legal 
obligations as purchasers of American goods. Injunctions and court 
proceedings became matters of common occurrence, but fortunately, 
courts both here and abroad maintained their earlier attitude and 
held that a bank which has issued a “confirmed credit has no option 
but to pay drafts presented against the credit, provided the conditions 
specified in the credit are complied with.”’ When a bank issues a 
letter of credit it promises to make certain payments to designated 
beneficiaries provided the conditions of the credit are fulfilled. Court 
decisions have uniformly held that if the shipper has complied with 
those conditions the bank has no option but to pay the draft or 
drafts that are drawn under the credit. “It has neither the right nor 
the power to go behind the transaction in the interest of its client and 
endeavor to assist the client in avoiding payment” even though such 
payment may “result in a loss to the client. If the routine specifi- 
cations called for by the letter of credit as to quality of goods, time 
of shipment or other details appear to have been complied with, any 
breach of contract between the buyer and the seller is a matter for 
litigation between them, and concerns the bank in no way. The bank 
is bound to pay, and an attempt to abet the efforts of clients who are 
seeking by questionable means to avoid losses will inevitably react 
against the bank which tries such a thing and the purchaser who in- 
stigates the action, and it will inevitably ruin the reputation of the 
American business community in foreign countries...” For- 
eign “sellers of goods to this country ship the goods with the under- 
standing that the credits against which their drafts are drawn are 
irrevocable, provided shipping documents are in order. They feel an 
absolute assurance of acceptance upon presentation. Of course, after 
a draft has been accepted by the bank, it is then the obligation of the 
bank itself which the bank is bound to pay at maturity. No legal 
action can possibly be maintained that would serve to prevent the 
bank paying at maturity its acceptance when presented by a holder 
in due course. All these attempts to evade the carrying out of con- 
tracts have been made with the idea of preventing a bank from accept- 
ing under the terms of its irrevocable letter of credit and have not had 
to do with drafts previously accepted. It is well to bear in mind that 
nothing can transpire which can effect the integrity of the banker’s 
acceptance after it has in fact become an acceptance. To allow any 


IMPORT AND EXPORT CREDITS 289 


movement to get started having for its purpose the slightest deviation 
from this would be disastrous and would result in the complete dis- 
appearance of the dollar acceptance outside of the United States. If 
the integrity of the dollar acceptance becomes impaired, American 
importers will be forced to resort to the humiliation of financing their 
purchases by means of sterling or other foreign credits.” } 

After giving a most comprehensive and excellent review of British 
decisions concerning commercial letters of credit, Mr. George W. Ed- 
wards of the Division of Analysis and Research of the Federal Re- 
serve Board ? concludes that the following principles may be deduced: 
“(a) A letter of credit is not a negotiable instrument. (b) It does 
not create a trust fund in favor of the beneficiary. (c) An issuer of a 
letter of credit may not dishonor drafts presented by a negotiating 
bank under a clean irrevocable letter of credit if all the terms of the 
credit are fulfilled. (d) Anissuer may dishonor bills drawn in violation 
of the conditions specified in a documentary letter of credit. The 
negotiator is not liable for the genuineness either of goods or docu- 
ments. (e) The issuer is responsible to the party requesting the credit 
for the observance of the conditions by the beneficiary. (f) The 
contract between the issuer and the beneficiary is entirely independent 
of the contract of sale between the buyer and seller, and the issuer 
cannot, because of the seller’s breach of contract of sale, refuse to 
honor drafts which comply with the terms of the letter of credit.” ® 

Recent American cases have closely followed the principles laid 
down by the British courts in such matters. Mr. Edwards, in the 


1The Americas, December, 1920, p. 2. 

2 Federal Reserve Bulletin, February, 1921, pp. 159-162. 

3 Ibid, p. 162. These conclusions are based on the decisions of British courts in the 
following cases: Orr & Barber v. Union Bank of Scotland (1854), 24 Law Times, Old 
’ Series, 1; Waterson v. Edinburgh and Glasgow Bank (1858), 20 Dun. (Ct. of Sess., 
642, Scot.); Sovereign Bank v. Bellhouse (1911), Quebec Reports, 23, King’s Bench, 
413; Morgan v. Lariviére (1875), Law Reports, vol. 7, House of Lords, 423; Bank of 
Toronto v. Ansell (1875), 7 R. L. Q. B., 262; Graham v. Mahony, Irish Law Re- 
ports [1st series], 385; Agra & Masterman’s Bank, ex parte Asiatic Banking Corpora- 
tion (1867), 36 Law Journal, Chancery, 222; Maitland v. Chartered Mercantile Bank of 
India, London, and China (1869), 38 Law Journal, 363; Oriental Banking Corporation 
vy. Lippert & Co. (1875), Buchanan’s Reports, South Africa, p. 152; Brazilian & Portuguese 
Bank (Ltd. v. British and American Exchange Banking Corporation, 18 Law Times, p. 
823; Union Bank of Canada v. Cole, 47 Law Journal, Queen’s Bench, p. 100; Chartered 
Bank of India, Australia & China v. Macfayden & Co., 64 Law Journal, Queen’s Bench, 
p. 367; Woods v. Thiedemann I. Hurlstone & Coltman, 478; Ulster Bank v. Synnott, Irish 
Reports 5, Equity 595; Guaranty Trust Co. of New York v. Hannay, 87 Law Journal, 
King’s Bench, 1223; Basse & Selve v. Bank of Australia (1904), 90 Law Times, 618; Borth- 
wick v. Bank of New Zealand (1900), 17 Times Law Reports, 2; Prehn v. Royal Bank of 
Liverpool (1870) Law Reports, 5 Court of Exchequer, 92. 


290 DOMESTIC AND FOREIGN EXCHANGE 


article cited, also presents a brief statement of the three outstanding 
decisions handed down by American courts from which statement 
the following quotations have been taken: 


“The case of American Steel Co. v. Irving National Bank, 266 Fed. 41 
(C. C. A., 2d Circuit, Apr., 1920), holds that the beneficiary of an irrevocable 
letter of credit has an absolute right to have the drafts honored by the 
issuing bank when drawn in accordance with the terms of the letter, and 
that the issuing bank cannot decline to honor drafts so drawn, even though 
requested to do so by its customer, because the contract of sale between 
that customer and the beneficiary has become impossible of performance. 
In that case the defendant national bank had issued an irrevocable letter 
of credit to the plaintiff steel company authorizing the plaintiff to draw at 
sight upon the national bank for account of the defendant MacDonnell 
Chow Corporation for $43,000 covering the shipment of tin plate. The 
plaintiff steel company had contracted to sell the tin plate to the defendant 
MacDonnell Chow Corporation f. 0. b. Pittsburgh for export. The plain- 
tiff shipped the tin plate and presented a sight draft'to the defendant na- 
tional bank with certain documents and the defendant national bank de- 
clined to honor the draft. The second defense alleged that by reason of 
the Federal prohibition against the export from the United States of tin 
plate the performance of the contract between the plaintiff and the de- 
fendant MacDonnell Chow Corporation became impossible of execution. 
The third defense alleged a resale by the plaintiff of the tin plate and claimed 
an offset of the amount realized on the resale. As to the second defense, 
Circuit Judge Rogers said: 


‘The second defense, that the contract became impossible of execu- 
tion, inasmuch as the MacDonnell Corporation was unable to obtain 
a license from the United States Government permitting the export 
of the tin plate, is wholly inconsequential. The liability of the bank 
on the letter of credit as agreed upon between plaintiff and defendant 
was absolute from the time it was issued, and it was quite immaterial 
whether the defendant could export the tin or not. The law is that 
a bank issuing a letter of credit like the one here involved cannot 
justify its refusal to honor its obligations by reason of the contract 
relations existing between the bank and its depositor.’ 


“The opinion then cites with approval the case of Sovereign Bank of 
Canada v. Bellhouse, Dillon & Co. (Ltd.) (supra) upon the point that the 
customer at whose instance a bank has issued an irrevocable letter of credit 
cannot compel the bank to cancel that letter, since the letter constitutes 
a contract between the issuing bank and the beneficiary. The opinion 
concludes: 


IMPORT AND EXPORT CREDITS 201 


‘The defendant in effect seeks to read into the contract a provision 
that the plaintiff’s rights under the letter of credit should be subject 
to the superior right of the MacDonnell Chow Corporation to modify 
the contract which the bank had made with the plaintiff. We do not 
so understand the law.’ 


“The case of Frey & Son (Inc.) v. Sherburne Co. and the National City 
Bank, 184 New York, Supp. 661 (Appellate Division, N. Y. Supreme Court), 
expressly holds that the contract between the issuing bank and the bene- 
ficiary, as evidenced by the letter of credit, is entirely independent of the 
contract of sale between the buyer at whose instance the letter of credit 
was issued and the seller who is the beneficiary under the letter of credit, 
and that the issuing bank cannot repudiate its contract with the beneficiary 
merely because of a breach of the contract of sale. The facts in that case 
were that the plaintiff had agreed to buy from the defendant Sherburne 
Co. 350 tons of sugar to be shipped from Java; payment for the sugar to be 
made in New York on presentation of warehouse receipt or delivery order 
and the plaintiff to furnish an irrevocable letter of credit for the full amount 
of the invoice. The contract also provided that the plaintiff, the buyer, 
should have the right to cancel the contract in the event that the shipment 
was delayed. At the instance of the plaintiff the defendant national bank 
issued a letter of credit to the Sherburne Co. authorizing that company to 
draw sight drafts upon the bank accompanied by specified documents 
covering the shipments of sugar. The letter of credit also contained a 
provision whereby the bank agreed with bona fide holders that all drafts 
issued in accordance with the letter would be honored upon presentation. 
The letter did not, however, refer to the plaintiff’s right to cancel the con- 
tract of sale if shipment was delayed. The plaintiff alleged that the ship- 
ment of 45 tons of the sugar had been delayed and that he had elected to 
cancel his contract for the purchase of so much of the sugar and that not- 
withstanding this the defendant Sherburne Co. threatens to negotiate or 
present for payment drafts drawn under the letter of credit and that the 
defendant national bank threatens to pay such drafts if so presented or 
negotiated. The relief sought by the plaintiff was an injunction restraining 
Sherburne Co. from drawing or negotiating drafts under the letter of credit 
and enjoining defendant national bank from honoring or paying drafts 
which have been or may be so drawn. In the opinion, Mr. Justice Green- 
baum says: 


‘From our view of the case it is not important to discuss the rights 
of the plaintiff under the contract with the defendant Sherburne 


Oe ee 
‘It is equally clear that the bank issuing the letter of credit is in no 


292 DOMESTIC AND FOREIGN EXCHANGE 


way concerned with any contract existing between the buyer and 
seller. The bank is only held liable in case of a violation of any of 
the terms of the letter of credit. It therefore would follow that, if 
the bank issued any drafts violative of the terms of the letter, the 
buyer would have recourse to the bank in an action for damages for 
the breach of its contract. Similarly, if the defendant Sherburne 
Company violated its contract with the plaintiff, the latter has a 
remedy in an action at law for damages against the defendant. It is 
not alleged in the complaint that the National City Bank is in financial 
difficulties. Nor is it alleged that the Sherburne Company is not 
financially able to respond to damages. Our attention has been called 
to Higgins v. Steinhardter (106 Misc. Rep. 168; 175 N. Y. Supp. 279). 
We are of the opinion that the facts appearing in the opinion of that 
case did not warrant the granting of an injunction. Interests of in- 
nocent parties who may hold drafts upon the letter of credit should 
not be made to suffer by reason of rights that may exist between the 
parties to the contract of sale in reference to which the letter of credit 
was issued. It would be a calamity to the business world engaged in 
transactions of the kind mentioned in this complaint, if for every 
breach of a contract between buyer and seller a party may come into 
a court of equity and enjoin payment on drafts drawn upon a letter 
of credit issued by a bank. The parties should be remitted to their 
claims for damages in an action at law.’ 


“To the same effect is the case of El Reno Grocery Co., etc. v. Lamborn, 
et al., reported in the New York Law Journal for December 15, 1920, in 
which Mr. Justice Cohalan of the Supreme Court of New York said: 


‘There are before the court 24 motions for injunctions pendente lite 
in equity cases brought for the cancellation of certain contracts for 
the sale of sugar which the plaintiffs have attempted to rescind. The 
decision on this application is decisive of the 23 other motions. To 
enjoin the defendants from collecting upon a letter of credit established 
in their favor, because the plaintiff alleges there is a dispute, default 
or breach'by the defendants of the contract is for the court to make a 
new, different and distinct agreement between the parties herein. 
This the court is not prepared to do. In my opinion the plaintiffs have 
an adequate remedy at law and there are no substantial reasons shown 
for invoking the extraordinary remedy of an injunction order. The 
plaintiff’s motion is denied and the injunction vacated.’” 


A recent decision by Judge J. M. Mayer in the United States Dis- 
trict Circuit Court in New York City is also of interest as further 
supporting the contention that banks deal in documents and not in 


IMPORT AND EXPORT CREDITS 293 


goods, and that even where the goods themselves conform to the sales 
contract the bank that has issued the letter of credit cannot be held 
to pay if the documents do not comply with the conditions called 
for in the letter of credit. The court held that: 


“The mere statement of the arguments pro and con destroys the plain- 
tiff’s case. When the bank issued this Letter of Credit, it did not purchase 
goods. It agreed to purchase documents in the sense that it would pay 
on receipt of certain documents which should conform in every respect 
with the requirements of the Letter of Credit. It was, of course, not con- 
cerned with the goods, but with the documents. It would gravely impair 
the business of issuing Letters of Credit if banks were required to construe 
the documents involved and determine arguable questions. The only safe 
tule for a bank is to refuse to pay if, by omitting, as here, a distinct and 
clearly expressed provision, the documents do not conform with the Letter 
of Credit.” ! 

Authority to Purchase. Authorityto Draw. Tmporters at times have 
recourse to what is known as an “Authority to Purchase,” some- 
times incorrectly called an “Authority to Draw,” as a means of 
financing their transactions on a credit basis.2 This document is 
seldom found outside of banking and trade circles of New York and 
the Pacific Coast. It is used primarily, if not solely, in the financing 
of Oriental trade, and almost always in facilitating exports from 
the United States. The authority to purchase is not a bank credit 
involving a banker’s acceptance. It involves nothing more than a 
trade acceptance, the negotiation of which is facilitated by the services 
of a bank in the importer’s country, which acts as the issuer of the 
authority, and a bank in the exporter’s country, which acts as the 
purchaser of the exporter’s draft. 

To make matters somewhat clearer, let us take the transaction 
which we have discussed above, involving the shipment of goods to 
the Java Motor Company, and see how the shipment can be financed 
by means of an authority to purchase. The Java Motor Company, 
being desirous of importing a shipment of trucks from the New York 
Motor Car Company, goes to the Netherlands State Bank and asks 
it to issue an authority to purchase in favor of the latter. The Java 
concern being well known to the issuing bank may or may not have 


1Quoted in Foreign Trade Bulletin of the American Express Company, September- 


October, 1921. ; 
2Cf. an excellent article on ‘‘The Authority to Purchase” in the Federal Reserve Bul- 


letin, August, 1921, pp. 926-931. 


294 DOMESTIC AND FOREIGN EXCHANGE 


to deposit security before the bank will furnish the desired accom- 
modations. If the bank consents, it asks the Java Motor Company 
to fill in and sign a “letter of guarantee.’ The Java bank then fills 
in another form, or merely types a letter to the same effect, asking 


IN DUPLICATE 


Cablea December_1, 1948 
AUTHORITY TO PURCHASE 


LETTER OF GUARANTEE) 
Singapore,., os RNecember 1, 191.8. 
HE NETHERLANDS STATE BANK 


bs = 3 : xgx : 
We beg to inform you that i have authorized 


———----The..New.York.Motor Company... to draw on = with recourse to 


days’ .. 
th tent _Four. thousand dollars ($4,000) = Sat ——*_ sight 
e extent of __Four thousand dollars (34,000) 90 7 9 


Bill of Lading, Invoice, 
insurance. Certificate, Consular Invoice, 


tw cover shipment of —-nine_(9) motor trucks 
Y 


SPO NOW LO ne —.-._- to Singapore 





Marine Insurance wy 


‘Fr ight to be by shigpor 
gp covered here 


paapaid 
paid at destination 


2 
We “ares. 1 To accept upon presentation all bills drawn pursuant hereto. 


2 Tohold the Netherlanéss State Dank barmless because of any damage to merchandise shipped or 


deficiency or defect therein or in the documents above described. 

@ That the said documents, or the merchandise covered thereby, and insurance shall be held as collateral 
security for due acceptance and payment of any drafts drawn hereunder, with power to the pledgée to acl 
in case of non-acceptance or non-payment of the draft to them attached, without notice at public or private 
sale and after deducting all expenses including commissions connected therewith, the net proceeds to be 
applied toward payment of said drafts, The receipt by you of other collateral, merchandise or cash, now 
io your hands, or hereafter deposited, shal] not alter your power to seli the merchandise pledged and the 
proceeds may be applied on any indebtedness by us to the Bank due or to become due, 


To psy your commission of -Mp—% for negotiating of drafts hereunder. 


This engagement to commence from date hereof and to apply to all Bills drawn 
within_.chrae.(3).....months 
mail. Yours faithfully, 
Please advise by Peeve’ 


Om 

To Manager —— Jaya. Motor Company." 
IRVING BATIONAL BAIK ~ 
__New York City, Me Yo oY 


- FRO FORMA 


The above is our A. P. Xo._891 Please do the needful, 


ae 


eee ie tans 


Yours very truly, 





FIGURE 79 
Authority to purchase (letter of guarantee) 


the Irving National Bank to purchase the draft drawn by the ex- 
porter and also giving other necessary instructions. This is the 
“authority to purchase.’”’ Some banks use separate forms for these 
two documents; others combine them into one form (Fig. 79). In 
short, all that the importing firm has done is to go to its local bank 
and ask it to arrange for, or to guarantee, a purchaser of the draft 
that is to be drawn on it (the Java Motor Company) by the New 


IMPORT AND EXPORT CREDITS 2905 


York exporter. Trade acceptances are not easily marketable, and 
especially do those drawn on Oriental firms have to be provided with 
assured purchasers in the manner under discussion. 

If the Irving National Bank is willing to carry out the transaction 
it writes the New York Motor Company, notifying it that it (the ex- 
porter) may draw on the Java Motor Company for a definite sum 
of money and that it (the bank) will negotiate the same for the Nether- 
lands State Bank (Fig. 80). This letter constitutes what is known 


IRVING NATIONAL BANK 
Cable Address 


NEW YORK “Trving Bank—New York ” 
Organized 1851 
In replying please quote ) 
Foreign Department Export Credit 
ADVICE # 600/100 
New York Motor Co. 
New York City, N. Y. 


Gentlemen: 

We are instructed by the Netherlands State Bank to negotiate as offered, 
without recourse, your documentary bills at ninety days sight on Java Motor 
Company, Singapore, to the extent of FOUR THOUSAND AND oo/r100 
DOLLARS ($4000.00) at one time outstanding, for invoice cost of goods 
shipped to that port. 

The bills must be accompanied by a full set of Bills of Lading (Express 
Company’s Bills of Lading not acceptable) and Insurance Certificates covering 
marine insurance and also war risk insurance, made out to order and endorsed 
in blank together with invoice covering merchandise shipped from America to 
Singapore, and shipping documents to be delivered against payment of the 
relative drafts. 

The drafts must be drawn to order, endorsed in blank and be marked. 

“Drawn under authorization of the Netherlands State Bank, # t00” and 
must bear the following clause: 

“Payable with interest added at the rate of 6% per annum from date of 
draft until approximate arrival of cover in New York.” 

This authorization is subject to cancellation and/or modification by us at 
any time. 

Kindly hand in this letter with your drafts in order that the amounts of the 
same may be endorsed on the back hereof. 

Yours very truly, 
PRO FORMA 
Vice President. 


Ficure 80—Authority to draw or advice of authority to purchase 


January 2nd, 1919 


2096 DOMESTIC AND FOREIGN EXCHANGE 


as the “authority to draw” or the “advice of authority to purchase.” 
This advice also contains directions for the guidance of the exporter 
in preparing the shipment and in drawing the draft. 

The exporter ships the goods, gets the documents, and draws the 
draft on the importer in dollars. Practically all drafts drawn under 
an authority to purchase are dollar drafts. They usually run for 
60, go, or 120 days. The exporter then takes the documentary bill 
of exchange (documents are almost always indorsed in blank under 
an A/P) to the Irving National Bank which pays the face value of 
the draft. The Irving National Bank immediately debits the account 
of the Netherlands State Bank with that sum plus charges. In order 
to reimburse the Java bank for interest lost as a consequence of such 
debiting, the customary interest clause is inserted in the draft.1 The 
documentary bill is sent to the Netherlands State Bank, which pre- 
sents it to the Java Motor Company for acceptance. The importer 
gets his goods and pays the draft at maturity plus interest and com- 
missions. 

Authorities to purchase may be revocable or irrevocable by the 
issuing bank, while authorities to draw (advices of authority to pur- 
chase) may be revocable, irrevocable, confirmed, or unconfirmed. 
When the Java bank sends an authority to purchase to the New York 
bank, it may agree to meet all obligations no matter what situations 
may arise. This is an irrevocable A/P. If it reserves the right to 
revoke the A/P at any time, it is a revocable credit. The New York 
bank may be asked by the Java bank to “confirm” the credit, and 
if it is willing to do so it includes in the authority to draw, which it 
sends the exporter, a statement worded somewhat as follows: 


‘We herewith open a confirmed credit in your favor” 
or 


“We hereby confirm the following credit opened at the request of n+ 





If a bank confirms the credit, it charges an extra commission, 
usually one-eighth of one per cent, because such confirmation adds 
the credit of the notifying bank to the transaction and also causes 
it to assume the liability as a “confirmer”’ or “guarantor.”’ 

If the credit is “unconfirmed,” the authority to draw will read 
somewhat as follows: 


1Cf. pp. 267-270. 


IMPORT AND EXPORT CREDITS 2907 


“Kindly note that this is not a confirmed credit, and is consequently 
revocable at any time, either by the parties granting the credit, or by our- 
selves under certain conditions.” 


or 


“Please note that this is an unconfirmed credit and is consequently sub- 
ject to modification or cancellation.” 


It is clear from these statements that an unconfirmed authority to 
draw is also revocable by the notifying bank, although not necessarily 
revocable by the issuing bank. When the credit is unconfirmed by 
the notifying bank, or revocable by the issuing bank, it is subject to 
cancellation at any time prior to the actual payment of the draft. 
If the credit is not confirmed by the notifying bank, it will receive its 
fee for acting as the representative of the foreign bank, for examining 
the shipping documents to see that everything is satisfactory and in 
accordance with the terms of the credit, etc. 

It will be noted that in the authority to draw given above (Fig. 80), 
the credit is revocable and that the draft is to be drawn “without 
recourse” on the exporter. Exporters frequently refuse to ship goods 
under an authority to draw unless it is confirmed and unless the 
drafts are to be drawn “without recourse.” ‘Several exporters of 
experience accept orders based on authorities to negotiate, without 
recourse, only for shipments of standard material and when billed to 
houses of undoubted responsibility and reputation for fair dealing. 
In all other cases they require either that an authority without re- 
course be given, or that some other arrangement be made whereby 
they may be assured of their money, in case the importer should 
refuse to pay.” ! 

In all of the instances of bank credits, it will be remembered that the 
draft was drawn upon a bank, either domestic or foreign, which meant 
the almost absolute certainty that the draft would be paid at maturity 
regardless of what happened to the importer, unless, of course, the 
drawee (accepting) bank should fail.? In the case of an authority 

1Irving National Bank, “Exporting to the Far East,” p. 79. 

2“Under the Law of Negotiable Instruments, any bona fide holder has full recourse 
upon the drawer of a draft under a letter of credit if the drawee bank dishonors the bill. 
Considering the question not from the strictly legal standpoint but from commercial usage, 
the drawer of drafts under a confirmed irrevocable letter of credit, issued by a reputable 
bank, may safely regard the transaction as closed upon acceptance by the drawee bank 


and he would be liable only in the extreme event of failure of the accepting bank.” Federal 
Reserve Bulletin, June, 1921, p. 685. 


298 DOMESTIC AND FOREIGN EXCHANGE 


to draw, which is not technically a bank credit, the draft is drawn 
against the importer who may become bankrupt before acceptance, 
or after acceptance and before payment. The banks act merely as 
agents in handling the transaction and if the exporter is not relieved 
from his liability by a “without recourse” clause he may be held 
liable by the negotiating banks for the face value of the draft plus 
protest charges, etc., just as in the case of an ordinary trade acceptance. 
It is because of this attendant risk that exporters do not favor the 
use of an authority to draw as a substitute for the more customary 
and reliable forms of bank credit. Most banks when they notify the 
exporter of the existence of an authority to draw make it clear to him 
that they are acting only as the representative of the foreign bank and 
that they are not opening a bank credit in his (the exporter’s) favor. 
The following clause is frequently used in this connection: “Please 
note that this advice [the letter to the exporter] is NOT to be con- 
sidered as being a ‘BANK CREDIT’ and does not relieve you from 
the ordinary liability attaching to the ‘DRAWER’ of a Bill of Ex- 
change.” 

In handling export credits, the notifying bank does not insist that 
the exporter negotiate his drafts with it. In fact it is quite customary 
for the exporter to negotiate his drafts with his own local bank from 
which he can undoubtedly receive a much higher rate than from the 
notifying bank. His local bank then presents the drafts and docu- 
ments to the notifying bank, so that the latter as a rule eventually 
gets possession of them. In the instance cited above, it would be 
possible for the New York Motor Car Company to sell its draft and 
documents to its local bank, say the National City Bank, which in 
its turn would dispose of them to the notifying bank, 1. e., the Irving 
National Bank. 

Letter of Delegation. ‘There is still another method that may be 
resorted to by the exporter in obtaining payment for his shipments. 
In this case he draws no draft, either on the bank or on the importer, 
but takes the documents to his local bank and asks it to forward them 
to its correspondent in or near the importer’s city. The correspondent 
is advised in a communication, called a “letter of delegation,” ! of 


1 Although the letter of delegation as previously described (pp. 195-196) was used in an- 
other connection, i. e., to pay funds to a designated party in a foreign country, in this case it 
is used by the exporter to get money for goods shipped. Nevertheless, in both cases it takes 
the form merely of a set of instructions or directions to a foreign banker or exchange dealer. 


IMPORT AND EXPORT CREDITS 299 


the terms under which the documents are to be turned over to the 
importer. This letter of delegation is not a bill of exchange; it is a set 
of instructions, and consequently is not negotiable. Neither does it 
have to carry any revenue stamps as negotiable instruments generally 


do. 


CHAPTER X 
RATES OF FOREIGN EXCHANGE 


The rates of exchange are the prices charged for the different grades 
or kinds of bills of exchange. Bills of exchange are similar to any 
other commodity that has a number of different grades and is sold in 
a competitive market, such as shoes, for example. There are many 
grades and styles of shoes with a different price for each, although 
sometimes different styles or grades may sell for the same price; this 
is true of bills of exchange. The prices of shoes may vary from week 
to week or from day to day because of certain conditions or factors 
in the market; so may the rates of exchange. The price of a pair of 
shoes may be “shaved”’ a little for the old customer or for a buyer 
of large quantities; so it is with bills of exchange. Continuing our 
analogy, we find that the shoe retailer is both a buyer and a seller of 
shoes. He has the price at which he buys from the jobber, the whole- 
saler, or manufacturer, and the price at which he sells to the public. 
Likewise in the exchange market we have the price at which various 
kinds of exchange are purchased by the dealer and we also have those 
prices at which the dealer sells his exchange to the public, or in the 
language of the exchange market itself, respectively the rates “bid” 
and the rates “asked.” Naturally it is the desire, and the practice 
wherever possible, of the exchange dealer to buy low and to sell high. 
In the exchange market, the public and the exchange dealers are 
simultaneously both buyers and sellers, the buying price of the ex- 
change dealers being the selling price of the public, and vice versa. 
The public as a seller is made up of exporters desirous of receiving 
money for goods shipped abroad, individuals wishing to be paid for 
services performed for foreign clients, tourists with traveler’s checks 
or foreign drafts to be cashed, etc., etc. Exchange dealers whose 
main stock in trade is a supply of foreign funds or credits are the most 
active sellers in the market. The public, as a buyer, is composed of 
importers who must pay for goods purchased in foreign countries, 
prospective travelers who wish funds for travel, customers desirous 
of paying foreign debts incurred for any of a number of reasons, etc. 

300 


RATES OF FOREIGN EXCHANGE 301 


Exchange dealers are continually in the market as purchasers of large 
amounts of exchange with which to replenish their stock of foreign 
funds or credits, of which they must always have an available supply 
in order to carry on their business. These two large groups, i. e., the 
buyers and the sellers, are the forces that influence the rates one way 
or the other. What their activities or desires may be, how much they 
can or are willing to pay or charge, depend upon certain other factors 
which will be considered in detail in this chapter. It must be recog- 
nized that in the foreign exchange field, as in the commodity markets, 
it is much easier for the smaller, better trained and organized group, 
viz., the dealers, to act effectively and to exert a predominating in- 
fluence in the market than it is for the unorganized public. Whether 
we consider the latter as being made up of buyers or of sellers, it can- 
not be so closely in touch with all those matters that determine the 
rates of exchange as can the smaller group of exchange dealers. The 
public knows nothing of the supply of or the demand for exchange; 
it is unacquainted with the influence of the discount rates of the cen- 
tral banks of Europe; it is ignorant of fluctuations that may be caused 
by foreign political developments, war, abundance or failure of crops, 
and other matters of similar import. Exchange dealers in the important 
financial centers watch such matters most carefully and attempt to 
gauge their rates both as buyers and as sellers in accordance there- 
with. Selling rates are fixed by the dealers on the basis of the buying 
rates and at a point where a profit is expected on the business as a 
whole, and not on any particular bill that they buy or sell. In this 
respect the exchange dealers again are similar to the shoe dealers in 
that when, for example, the shoe dealer buys his spring stock of goods 
he attempts to fix his prices at a point that will net him a profit on 
his business as a whole. He may lose on one style of shoes or on a 
few sales, but he hopes to gain on his total business. 

It is impossible in a discussion of retail prices to go into the details 
of why each and every retailer fixes his prices at this or at that point, 
and the same holds true in a discussion of exchange rates. It will be 
necessary, therefore, for us to confine our discussion to those more 
important factors that in general affect exchange rates in normal as 
well as in abnormal times. 

It is advisable, first, to explain briefly the methods foilowed in 
quoting the exchanges on various countries so that the reader may 
be perfectly clear regarding all matters subsequently discussed. 


302 DOMESTIC AND FOREIGN EXCHANGE 


In Chapter VI it was noted that as between countries actually 
on a gold standard basis, i. e., where all forms of money are readily 
redeemable either directly or indirectly in gold, where gold may be 
freely obtained for export and for domestic use, and where the mints 
are open to its free and unlimited coinage, the rates of exchange in 
normal times fluctuate around what is known as the “mint par of 
exchange” (more commonly known only as the “par of exchange’’); 
that as between a silver standard country and a gold standard country 
the rates of exchange fluctuate on a basis of the purchasing power 
of the gold monetary unit of the latter country measured in terms 
of the silver monetary unit of the former country, or, in other words, 
on the basis of the gold price of silver; and that as between a gold stand- 
ard or silver standard country on the one hand and a country having 
an irredeemable paper currency on the other, exchange rates vary in 
accordance with the purchasing power respectively of the gold or the 
silver monetary unit of the former countries as measured in terms of 
the paper monetary unit of the latter.'. A discussion of the exchanges 
of silver standard, paper standard, and gold exchange standard coun- 
tries will be taken up in Chapter XII. 

The practice of quoting exchange rates is different in different 
countries regardless of whether or not they are on the same monetary 
standard. It is needless for us to take up all the different variations; 
therefore only a few of the more important types will be considered. 
All of the practices followed, however, may be grouped under the fol- 
lowing three methods: (a) fixed exchange, or what Whitaker calls 
“direct” exchange;? (b) movable exchange, or what Whitaker calls 
“indirect”? exchange,® and (c) premium and discount exchange.* 
Fixed or direct exchange is where we quote the value of the foreign 
unit of currency in terms of the money of the home country In quot- 
ing English exchange, for instance, we say that the pound sterling is 
worth 4.85, 4.86, etc. As the pound sterling falls in value we give 
less of our money, say 4.82, for it, and as it rises in value we give more, 


1Cf. pp. 122-123. 

20D. cit., Pp. 73. 

3 [bid. 

4Mr. C. S. Reuter of the Merchants National Bank of Los Angeles suggests that the 
terms ‘‘fixed”’ or “direct quotations” and “movable” or “indirect quotations’’ be used 
so as to avoid confusion inasmuch as banks sometimes use the term ‘‘direct exchange” 
as referring to the exchange which they sell on their own foreign accounts, and “‘indirect 
exchange”’ as referring to the exchange which they sell on the foreign accounts of their 
American correspondents. 


RATES OF FOREIGN EXCHANGE 303 


say 4.90. In other words, we buy it as we would a lead pencil or any 
other commodity, i. e., on the basis of what it is worth in dollars and 
cents. Movable or indirect exchange is a little more difficult to com- 
prehend because we then quote how many units of foreign money can 
be purchased with one unit of home money, i. e., London asks how 
many francs, marks, dollars, etc., can be purchased with a pound 
sterling. Instead of saying as we do in the case of fixed exchange 
that lead pencils are 5 cents each, we say, in quoting movable ex- 
change, that we can get 20 lead pencils for one dollar. If lead pencils 
rise to 10 cents each, we say, quoting on the basis of movable exchange, 
that we can get only ro lead pencils for one dollar. The higher the 
value of the pencils, the fewer we get; the lower the value, the more 
we get. When London quotes francs at 25.20 per pound sterling, and 
later quotes them at 26, it means that more francs are obtainable per 
pound sterling, or that francs have fallen in value, even though the 
quotation as a numerical quantity is greater. When the London 
quotation is 20.35 francs per pound sterling it means that we get 
fewer francs at that rate, that they are more valuable, even though 
the quotation as a numerical quantity is smaller. As is frequently 
said, ‘The higher the rate, the lower the price; the lower the rate, the 
higher the price.”” The rule to follow in dealing in fixed exchange is 
to buy at the low quotation and sell at the high, but in dealing in 
movable exchange the rule is to buy at the high quotation and sell 
at the low. 

The discount and premium method of quoting exchange is used 
between countries that have the same monetary unit. Taking for 
example the United States and Canada, we note that New York on 
May 1, 1921, quoted the Canadian dollar at 10% per cent discount, 
i. e., to obtain a Canadian dollar draft would have cost a New Yorker 
but 89) cents of American money. If there had been a great demand 
for Canadian dollars, a demand much greater than the supply, the 
rate might have been quoted at a premium, possibly a 1 per cent pre- 
mium, which would have meant that fora New Yorker to get a Cana- 
dian dollar’s worth of exchange he would have had to pay $1.01 in 
American money. In some cases in using the premium and discount 
method only the rate of the premium or discount itself is given in the 
exchange tables, i. e., 1 per cent premium, 2 per cent discount, etc.; in 
others the cost of one unit or 100 units of the foreign money in terms 
of the home money is given, i. e., Canadian exchange may be quoted 


304 DOMESTIC AND FOREIGN EXCHANGE 


at $.98, or $98.00; while in still other quotations, the cost of a unit of 
the foreign money is expressed in terms of a percentage of the home 
money, e. g., Canadian exchange in New York may be quoted as being 
at 98 per cent of par, 102 per cent of par, etc. London quotations of 
the pound sterling of South Africa and of Australia offer an interest- 
ing example of how in one country two separate types of the premium 
and discount method are employed in quoting the value of the same 
monetary unit current in two other countries. The following table is 
taken from the London Economist of May 21, 1921: 


TABLE I 
SoutH AFRICAN EXCHANGE RATES 


The South African Banks quote the following rates: 


Union of South Africa Union of South Africa 
From May 13, 1921 From May 16, 1921 
London on South Africa South Africa on London 
Buying Selling Buying Selling 
ead creams 1/2% prem. 1/2% dis. 1/2% prem. 
Demand 2.40.) Yoadise ist. t1/4% “: otja to z/ateee 
BO tm sot 13a 21/8% ™ 1/8% dis. 
GO nw ees 2 t/20a A ee) 1/202 
sen ieee SAE 3 L/4vo Fae ibs oe 718%“ 
TOO Rs ae Afi ae Sit acne 


OVERSEAS DOMINIONS RATES 


Commonwealth of Australia and Dominion of New Zealand 


London on Aust. & N. Z. Aust. & N. Z. on London 
Buying Selling Buying Selling 
Aust. N.Z. Aust. N. Z. Aust, NS 2.  AUsin ieee 
Canlew ie. 99 99 1/2 IOI 102 I/2 103 
On demand..96 1/2 96 1/2 par par 100 3/8 100 ror 7/8 ror 7/8 
30 days... .95 7/8 95 7/8 99 3/4 99 1/2 tor 3/8 ror 3/8 
Diets oe 95 1/4 95 1/4 99 1/8 99 100 7/8 ror 7/8 
OO Ree 94 5/8 94 5/8 98 1/2 98 100 1/2 100 1/2 
PIC Shy ioe 07 7/8 @o7 74 
gumonths sight i.94- sen ay od aaa 97 1/4 


Ganonths sight es gunigen sees 96 5/8 


RATES OF FOREIGN EXCHANGE 305 


The above tables show that on May 13, 1921, London banks were 
buying demand exchange on South Africa at one per cent discount 
and selling it at 3/8 per cent premium; in other words, they were buy- 
ing £100 on South Africa for £99 and selling at £100 3/8 (£100 7s 6d) 
per £100. At the same time, they were buying demand exchange on 
Australia at 9614 and selling at par (100 per cent); in other words, 
they were paying £9614 (£06 tos) for £100 worth of demand exchange 
on Australia and selling it for £100. The use by London of both of 
these methods of quoting discount and premium rates (a person might 
think that only one method would be employed) has no rhyme or 
reason, and can only be explained on the basis of long standing custom 
and tradition. Somehow it got started and somehow it has continued 
to date without a demand arising for a change. In the financial world, 
as in all other fields, it is difficult to uproot custom no matter how 
foolish and useless the practice may become. 

There has been a noticeable tendency among American exchange 
dealers to adopt a uniform system of quoting exchange by the fixed 
exchange method, as is evident from the following table taken from 
the New York Journal of Commerce and Commercial Bulletin of 
December 17, 1921: + 


TABLE II 
OPEN MARKET QUOTATIONS 


Open market quotations for sterling and Continental exchange yesterday 
for large amounts were as follows: 


Range Close Prev. Close 

LONDON—Par $4.8665 per pound 
a Bankers’ 90 days..........0esss 45 23.5/3, 50 4.11% 4.11% 4.13 
Bankers’ COOMA Vat ate eo cee ens aes Aeis S/o. 8 4.13% 4.1334 4.15 
Moemaenn sterling) ..4 52. .0sents ss 4.17 5/8 a 4.15% 4.1534 4.17 
Ser MP TA NSTCTS «5 “ein: e's cules ck dhiaee AIO L/Oua) A510 4.16% 4.17% 
Bills— 

Bre AACS ..)). Sis, Vic's cule canes oy 4.16% @ 4.141/8 4.14 3/8 4.15 5/8 

Seer ISIP NE. Soc ats hele tomate 4.167/8 @ 4.1434 4.15 4.16% 
Documents for payment— 

60 days, against grain........... 4.125/8 @ 4.10% 4.1034 4.12 

ae BIO GAYS ja2 nels 9 ov hardatates 4.11% a 4.09 3/8 4.09 5/8 4.10 7/8 

ee IO ORY 93 i's veh keen oe A:12% a 4.103/8 4.10 5/8 4.11 7/8 


1 Tables of exchange rates similar to the one shown are to be found on the financial pages 
of the large metropolitan papers and in the financial and commercial weeklies, such as 
the New York Journal of Commerce and Commercial Bulletin, the Commercial and Financial 
Chronicle, the Annalist, etc. Monthly surveys of the range of exchange rates are also pub- 
lished in the Monthly Bank and Quotation Section of the Commercial and Financial 
Chronicle. 


306 DOMESTIC AND FOREIGN EXCHANGE 


TABLE Il—Continued 


OPEN MARKET QuorTraTIONS—Continued 


Range Close Prev. Close 
CANADIAN EXCHANGE IN N. Y.—Par tooc per Canadian dollar 
CHECKS Ay dean ee ek Ala cares 7 3/8 per cent. discount 
PARIS—Par 19.3c per franc 
Bankers; Checks) Sper si es Belen oe 7.90 @ 7.98 7.78 7.92 
Bankers Cables aera seth esa eae 7.9L @ 97.79 7.79 7.93 
Com], checks. scons chasaten rae 7.88 Gois7t76 7.76 7.90 
CONT OO GAYS Seat eka so ene 7.82 a “9570 7.70 7.84 
ANTWERP—Par 109.3¢ per franc 
heck. 240 Gaede at eee see 7.60 @: 'e7.40 7.49 7.62 
Coo btes 2% sues <r career oe ee 7.6L De Be 7.50 7.63 
BERLIN—Par 23.8c per mark 
Bankers? checks) 5,055 pikeeota $.005034 a $.0048%  $.0049 $.0052 
Cables.s.2\ cae vente e silat OM amas .0051% a .0049 .0049% .0052% 
AUSTRIA—Par 20.3c per krone 
Chovka: Su ot foie wae Bs Bid a4 $.0003% a $.0003% $.0003%  $.0003% 
Cables..... ie VR CSE She'd obec .000334 a . 000334 .000334 .0004 
HUNGARY—Par 20.3c per krone 
CCHSCES Gud ngieste iy By 4 foie tor ee we 14% a 14% 14% 15 
ITALY—Par 19.3¢ per lira 
Bankera: siehtiig Se er sh Bee wlcs 0 u's 4.59 @ 4.50 4.50 4.52 
Bankers, Capleszcise eo oe cio ay ce 4 4.60 C) rast A. st 4.53 
HOLLAND—Par 40.2¢ per florin 
Barkers seiehty aie gas ee ase aes 2% 36.41 a 36-06 ails 36.30 
Bankera Calls sos ae ase hes ss 36.46 a@ 36.30 36.38 36.35 
CSCC SUNT KM y areata ee via « 36.36 a@ 306.20 36.28 36.25 
Bankers’ 66 dayss o3 sGiuw Mhoaees ci 36.00 a@ 35.84 35.92 35.80 
SWITZERLAND—Par 19.3c per franc 
Bankers ‘Qoecksi ses vn enti e os 19.38 @ 10:45 19.38 19.35 
Bankers’ ‘cables: ... svi gona he | 19.43 a@ 19.40 19.43 19.40 
GREECE—Par 19.3c per drachma 
Bankers’ checks’... 2 ds sasdek eae oss 4.11 OAL 4.11 4.20 
Bankers” cables.covke > wane ee 4.16 a 4.16 4.16 4.25 
TURKEY—Par $4.40 per Turkish pound 
Checks iie.. (20. ose aka ene 59 a 59 59 60 
DENMARK—Par 26.8c per kronen 
Bankers’ checks v.14. isn eee 19.28 @ 19.20 19.20 19.30 
Bankers’ cables i5.s 04 64. eee 19.33 @ 10725 19.25 19.35 
SWEDEN—Par 26.8c per krona 
Bankers’: checks 045.: a+ + +0. seus 24.45 @ 24.40 24.40 24.65 
Bankers’scables.. yi. a0. kn a oe 24.50 @ 24.45 24.45 24.70 
NORWAY—par 26.8c per krone 
Banker's checks <0 s'ascyie« wake 15.56 Pp ae Bea 15.40 14.45 
Bankers cablesi-. cs asters oe 15.61 @ 15.44 15.45 15.50 
SPAIN—Par 19.3c per peseta 
CNECES 3.0 actacw cite ie ace eee 14.65 a TAsse 14.54 14.85 
Cables. iss. chs eet tae eee 14.70 @ 14.50 14.59 I4.90 
CZECHO-SLOVAKIA—Par 20.3c per crown 
Checka se ..2. ee lake ee tis eer a oe 1.22 @ 3:22 1\22 1.92 
ROUMANIA—Par 19.3¢ per leu 
Checks ts ori S50 ie eee eee .85 a .85 .85 87% 


POLAND—Par 23.8c per mark 
Chedkase vas cobs umol pre bad paras $.0325 a $.0325 $0325 $.0312% 


RATES OF FOREIGN EXCHANGE 307 


TABLE II—Continued 
OPEN MARKET QuotTaTions—Continued 


Range Close Prev. Close 

SERBIA—Par 109.3c per dinar 
OS RS A ae ee ee 154 ba ti 84 1.54 1.58 
FINLAND—Par 23.8c per mark 
CME tag inci piled casio s shes s os 1.85 eB eT 1.85 1.85 
PORTUGAL—Par $1.08 per escuda 
SR eas). ba enw vss wo 0s 7.81% a 7.81% 7.8114 7.871%4 
JUGO-SLAVIA—Par 20.3c per crown 
ee ieee 6. aad wk 6 6 4 vee 38% a 38% 38% 
BULGARIA—Par 109.3c per leu 
Ree le ies oes 6 0,60 cine 70 a 70 70 75 
RUSSIA (exch.)—Par 51.46c per ruble 
RM RN es cis «an os 9c per 100 rubles 

SOUTH AMERICA— 
ARGENTINA—Par 42.45c per paper peso 
DMM Re ins 5d ode Gx) e vw 5 oe 33 1/8 a 33 1/8 33 1/8 33% 
ESS Ss ee Cee ifs 3334 3314 33 3/8 
BRAZIL—Par 32.45c per paper milreis 
os OS SOR Ls te te a, 12% a 1234 1234 12 7/8 
COEUR ED, lids facts ase aralee uve ewes 12 7/8 a 12 7/8 12 7/8 13 
BOLIVIA—Par 4oc per boliviano 
OSE OS A a aia 20% a 20% 20% 20% 
COLOMBIA—Par 97.33c per peso. . 
PMO eEEET Kile). Subsea cl. 4's Rahat ove 893%, a 8034 8034 80% 
ECUADOR—Par 48.7c per sucre 
POMBE SOO) 2 2 «dela vise leek 29.7% o 27.977 27.77 
MTPORMERELICCL AY, 5 — vhaly cia Ausd'< vie ee ER 24.10 @ 24.10 24.10 
URUGUAY—Par 103.42 per peso 
Oa A a a Sherer, ce 690 7/8 a 69 7/8 69 7/8 70 
VENEZUELA—Par 10.3c per bolivar 
PRC Se gn Nes ied ee 17.50 @ 17.50 17.50 16.25 
PERU—Par $4.8665 per pound 
An dc EL icine + hid reishainte a 4s S.5e Hy Pee a 7te 
CHILE—Par 36.s50c per paper peso 
DEN fe aay OO ais J aoa cela umes 10 5/8c per U. S. money 

ASIA— r 
SHANGHAI ON LONDON— 
Four months’ bank credits......... 2s. 8 5/8d. 
HONGKONG ON LONDON— 
Four months’ bank credits........ aan Od. 
JAPAN ON LONDON— 
Four months’ bank credits......... 2s. 4 5/16d.- 

FAR EASTERN CHECK RATES— 
POMNRMEM IE et, Sk acd soe tate nts Re 5434 a 55 
RMRMTERE Creston, C9 e044 bcs inact etoase ve 78% @ 7814 
SS ae ee eee ep 48% a 48% 
OO aS LE oN gripe el Re 48% a 4834 
BEEN EC i, oss)c oe. bea Rates ei 4834 @ 49 
NPI ck 063 its case's. wn eshalad ate ott 28% a 28% 
MEMORY eo he ces < 6 ches Son be Ss 28% a 2834 
a Aes bos ais ess soe Ee eae 35% a 3534 


In a general way sterling quotations involved transactions approximating £10,000 or 
more. In the case of Continental quotations rates cover amounts representing $100,000 
or over. + Nominal. 


308 DOMESTIC AND FOREIGN EXCHANGE 


Without dealing to too great an extent with the details of the table, 
it may be well to explain briefly some of its items so that the reader 
may be informed as to their meaning. The terms “Check,” “ Bankers’ 
sight,” and “Demand bills” all have reference to the same type of 
exchange, i. e., bankers’ sight drafts on a foreign center. The high 
and the low quotations are given, together with the rate at the close 
of the day and the rate at the close of the previous day. ‘“ London— 
par $4.8665 per pound” of course refers to the mint par of sterling 
exchange measured in terms of the American dollar. Mint par is 
given in all cases except for those countries that are on a silver or 
paper standard basis. It will be noted that all quotations, except for 
Canada, are based on the value of the foreign unit in terms of American 
money, i. e., fixed exchange. Canada is quoted on the basis of premium 
and discount. Under the London quotations the terms “ Bankers’ 
go days,” “Bankers’ 60 days,” and “Demand sterling,” all refer to 
drafts of those usances sold by bankers on their London accounts. 
“Cable transfers” needs no explanation. “7 day grain bills” are 
bills that are drawn against grain shipments, payable 7 days from date, 
which amounts to practically the same thing as a sight draft on the 
drawee. ‘‘Commercial sight” has reference to sight drafts that are 
drawn against shipments other than grain. “Documents for payment, 
60 days against grain”’ refers to 60 day drafts that are drawn against 
grain shipments where the documents go forward with instructions 
“D/P.” “Commercial 60 days” and “Commercial 90 days”’ refer to 
drafts that are drawn against shipments of various sorts where the 
instructions are that the documents are to be released on acceptance. 
It will be noted that the table also includes three quotations of Oriental 
markets on London, namely, Shanghai, Hongkong, and Japan. The 
rates refer to the cost in English money of sterling letters of credit 
against which four months’ drafts are to be drawn. The table con- 
cludes with eight quotations dealing with Far Eastern check rates, 
giving the cost in New York for sight exchange on those centers per 
unit of foreign currency, i. e., 54 3/4 cents bid and 55 cents asked per 
Hongkong dollar, or 78 1/4 cents bid and 78 14 cents asked per 
Shanghai tael, etc. etc. 

Under the requirements of the Emergency Tariff Act of May 27, 
1921, the Federal Reserve Bank of New York certifies daily to the 
Secretary of the Treasury the buying rate for cable transfers on the 
different countries of the world. The following table which needs 


RATES OF FOREIGN EXCHANGE 309 


no explanation is taken from the Journal of Commerce and Commer- 
cial Bulletin of December 17, 1921: 


TABLE III 

Country Rate Country Rate 
ONS, ee $ .000406 SE Dic Memes et tore ia $.01587 
RRC RI DY iit «vei te ia ats .0780 Sal pean a ssch he ie o 8 .1504 
PILE CMO {hy inde a... f< .007592 SWedenins tees. cide . 2465 
Czecho-Slovakia........ .012138 Switzerlandy nese aes L044 
LAD TiN a eh ee Mba ds TI OneK One wae rtd. . 5413 
mL cee Are Ula. 4.1991 shanghal, tael.. 24. 3) 27483 
UTS Oe ee .or18g2I Shanghai, Mex. dollar.. .5432 
LS oe eee ae .O8II India ae ae yt . 2767 
TEDL i ea digs = so 22s .005463 GLUE aRR eto Weky wl, ic yet .4788 
SRC OOC Rete he cue res 3 .0420 AVES ewe else eee ae . 3567 
PEPTIC te oo te a Foe oi 3642 BINPADGTEs er cutie .4742 
PRIMAL Ve euler. ss de as .001480 Sane aes ct we sie .924375 
EEA AY a ke Balls ee .0462 CUDA Ie Ua pee tet .996255 
AOS OLAVIG es, cis ic chels ss .003041 iil ss a0ee, MR 8 iy ar .4919 
Pe War tore vite 3 ks Sr553 Newfoundland........ .9225 
Sat ES le co A eR . 000303 ATCentind es eis oda -7509 
MACE LUG TAL eae oe 6G.) eee .0708 Metcital Wyte Pes eee .1274 
BSUPIATIOWE ty h dws wo iane .00871 Uruguay. ver ater te. .6911 


In many of the exchange lists, quotations will be found joined with 
the sign “@”’, e. g., 3.73 3/4 @ 3.7414. This does not mean, as one 
might surmise, that the selling rates for the particular kind of ex- 
change in question ranged between the two quotations given. The 
rate that precedes the sign represents the rate bid by the buyers, while 
the rate that follows the sign is the rate asked by the sellers at the open- 
ing of the day’s market. 

The English follow a less uniform practice than the Americans in 
their published tables of exchange quotations. They quote about 
one-half of their rates as movable exchange; the remainder, with only a 
few instances of premium and discount exchange, are quoted as fixed 
exchange. The following table is a portion of the daily “Money 
Market” article appearing in the London Times, December 2, 1921: ! 


1The London Economist (weekly) also devotes considerable space to tables of exchange 
quotations. 


310 


TABLE IV 


DOMESTIC AND FOREIGN EXCHANGE 


“The outstanding feature in the foreign exchange market was a further 
distinct improvement in the value of the mark. The Berlin rate at one 
time fell to 7oom., closing at 73714m., against 95714m. on Wednesday. 
Vienna fell a further 1,250kr. to 12,25okr. (having been down to 11,500kr.). 
The franc and lira appreciated, Paris closing at ssf. 63!4c., Brussels at 
57f. 5714c., and Rome at g5 Ir. 25. Rates on Switzerland (21f. o8c.), and 


Holland (11fl. 37c) moved further against those countries. 


After rising 


to 4.05, New York closed at 4.0434—a rise of 44%c. The following rates 


were current yesterday: 


Method of Par of 
Place Quoting Exchange 
New: Yorkiiveese es. to £ 4.86 2/3 
Montréal. 23 havea $ to £ 4.86 2/3 
pr het ie ate ra a ks AE ae Fr. to £ 25.221/2 
Brussels. iis ceee oe Fr. to £ 25.22 1/2 
Dtaly car. ares Lire to £ 25.22 1/2 
Hermes. coos eert Fr. to£ 25.22 1/2 
Athenseiccs. ives. Dr. to £ 25.22 1/2 
Helsingiors. .... jose M. to £ 25.22 1/2 
Madtid “ects aeeee Pts. to £ 25.22 1/2 
LASDOR Ts  ueterne he Per escu. 53 1/4d 
Amsterdam......... Fl to £ I2.107 
Berne. 340 tego M.to£ 20.43 
Viena cnt wees Kr. to £ 24.02 
Budapest.cr epee ee Kr. to £ 24.02 
Peacne> (4.9 -cieee oe Kr. to £ 24.02 
Warsaw. usiiomrase M. to £ 20.43 
Buksrests. tte Lei to £ 25.22 1/2 
Constantinople...... Pst. to £ 110 
Belprade: so ieneoes Din. to £ 25.22 1/2 
Cela. re jtet. Vergo nee Lev. to £ 25.22 1/2 
Christiania 72.8. 1:4 Kr: to'% 18.150 
SSLOMC DHOIEET eee che ly Kr. to £ 18.159 
Copenhagen........ Kr, to £ 18.159 
Alexandria elects ae Pst. to £ 97 1/2 
BOMDBY. 24 age cies Per rup. 24d. 
Calonttart. Cec eke Per rup 24d. 
Marlvat aes. tis i ok ane Per rup 24d. 
Hongiong. cs. secs Per dol. 
Yokohama) ; sss Per yen. 24.58d. 
el er AAT dt A Ee ee ts Per tael 
Singapore. ......... Per dol. 
Bands (33. ca eee Per dol. 24.066d. 
Rio de Janeiro...... Per mil. 27d. 
BrAres< Do. ee se. Per dol. 47.58d. 
Valparaiso, 90 days. .$ to £ $13 1/3 
Montevideo, T. T...Per dol. 51d. 
LAM Pern ee ons Eng. to Peru£ Par 
Mesicov74 oat es Per dol. 24.58d. 

* Nominal. 


December 1 


4.00 1/2-4.05 
4.37-4.32 
55-50-50.85 
57-55-59.30 
94.00-96. 25 
ZF. OO-21 7140 
99.50-100.50 
225-235 
28.80-28.907 
4 1/2-5 

IT. 30-11 40 
700-825 
I1I,500-13,500 
2,500—3,000 
360-370 
I2,000-14,500 
* 


730-780 

275-325 

620-700 
28.20-28.45 
16.86-17.00 
21.55-21.70 

97 7/16 

1/3 15/16-1/4 1/16 
1/3 15/16-1/4 1/16 
1/3 15/16-1/4 1/16 
2/8-2/8 3/4 

2/4 7/16-2/4 9/16 
3/10-3/11 

2/3 13/16-3 15/16 
2/4 1/2 

8 

431/2-43 7/8 
38.90 

40-421/2 

121/2% Prem. 

32 1/4-33 1/4 


No quotation. 


November 30 


3.99 1/4-4.00 1/2 
4.36-4.38 
56.30-57.25 
58.90-60. 10 
95 1/2-97 3/4 
20.95-21.10 
99.50-100.50 
230-240 
82.75-28.88 
4 5/8-5 1/8 
II.20-11.30 
930-1050 
I3,000—-14,000 
2,Q00-3,500 
370-380 
I3,000-14,500 
* 


135 ta 6 
280-320 


650-700 

28. 00-28. 20 
16.90-17.00 
21.45-21.62 

07 7/105 

1/3 15/16—-1/4 1/16 
1/3 15/16-1/4 1/16 
1/3 15/16—-1/4 1/16 
2/8-2/9 

2/4 11/16—2/4 15/16 
3/10-3/11 

2/3 13/16-3 15/16 
2/4 3/4 

7 3/4 

43 3/4-43 7/8 
39.10 

39 3/4-40 1/2 


324%4-331/4 


RATES OF FOREIGN EXCHANGE 311 


“The price of Gold fell a further 4d. to ro2s. 7d. per ounce (fine). All 
available supplies were taken for New York. 

“There was a recovery of 1/8d. to 37 5/8d. per ounce in the cash price 
of bar Silver, owing to some bear covering, but the forward price remained 
at 3714d. The market closed steady.” 


With but a few exceptions, the rates quoted are for telegraphic 
transfers on London at the foreign points mentioned. Inasmuch as 
the greater part of the world’s exchange is drawn in foreign centers 
on London, and not in London on those centers, it is readily seen why 
it is that London customarily quotes the rates existing in other centers 
on London rather than the rates in London on those centers. Before 
the abandonment of the Royal Exchange, the rates at which its 
transactions were handled were published Wednesdays and Fridays 
of each week, which were the days following the meeting of the Ex- 
change. Inasmuch as these rates were those prevailing in London 
on other centers they were not considered so important as were the 
published daily rates of foreign countries on London. 

In the London Times table, reproduced above, it will be noted that 
the first twenty-three rates, excepting that on Lisbon, are indirect 
(movable exchange) quotations, i. e., how much foreign money can 
be purchased with one pound sterling. The Lisbon rate and the rest 
of the rates in the table excepting that on Lima and Valparaiso are 
direct (fixed exchange) quotations, i. e., how much does one unit of 
foreign money cost in terms of English money, either in pounds sterling 
or in pence. Lima alone is quoted on the premium and discount 
basis, while the Valparaiso rate is quoted on the indirect basis. The 
South African and Australian rates which usually appear in separate 
tables have already. been discussed.! 

There are one or two items in the above table that may justify 
further explanation. In the opening paragraph where the Berlin 
rate is dealt with, the letter ‘‘m” refers to marks. In the next sen- 
tence the abbreviation “kr” has reference to the Vienna kronen. In 
the statements concerning Paris, Brussels, and Switzerland the ab- 
breviations ‘“f’’ and “c,’ mean francs and centimes, while in those 
concerning Holland the abbreviations “fl” and “c” refer to florins 
and cents. The quotation on New York is given in terms of dollars 
and cents. The second column explains the method of quoting the 
exchange while the third column gives the par of exchange where a 


1Cf. p. 304. 


312 DOMESTIC AND FOREIGN EXCHANGE’ 


par exists. The last two columns contain the buying and selling rates 
of exchange on the two days preceding publication. It will be noted 
that with Hongkong, Shanghai, and Singapore, there is no par of 
exchange, while with Lima the Peruvian pound is the equivalent 
of the English pound. The money market article concludes with a 
statement concerning the price of gold and silver. It is stated that 
the price of silver rose slightly, “owing to some bear covering, but the 
forward price remained at 37'%c.” This refers in the first place to the 
purchases made by silver dealers who had previously sold silver for 
future delivery, hoping to obtain it when needed at a lower price than 
that at which they had sold it. On December 1, they undoubtedly 
felt that the price had reached its lowest point, or else they were forced 
into the market to buy in order to deliver silver to purchasers, and 
their demand, as a consequence, exerted a strengthening influence 
on the price of silver. The “forward” price of silver is the price for 
delivery two months hence. 

Published tables of rates are known as the “posted” rates and are 
by no means the rates at which the greater part of the business is 
transacted. As was noted in the case of the table taken from the New 
York Journal of Commerce and Commercial Bulletin of December 17, 
1921, the quotations of sterling given were applicable to transactions 
of £10,000 or more while the Continental quotations were effective 
for amounts of $100,000 or over. Every dealer has a list of rates 
(posted rates) at which exchange is sold to the general public when 
ordinary amounts are desired, but these rates are either raised or 
lowered respectively for small or large purchases, or for strangers or 
old customers. The rates at which sales are made are known as the 
“actual” rates. The difference between these two groups of rates is 
shown by a comparison of the following tables taken from the Commer- 
cial and Financial Chronicle, Bank and Quotation Section, of Decem- 
beriigrn: 2 


TABLE V 
POSTED RATES—BANKERS’ STERLING BILLS 
Nov. 60 days Demand Nov. 60 days Demand Nov. 60 days Demand 


r 484 4 8736" Al dea 4 S74 Holiday 
2 484 ee Fi Sunday 8 484% 487% 


3 484 487% 6 484% 487% 9 484% 487% 


1 Pp. 20-21. 


Nov. 60 days Demand 


487% 
4 874 
Sunday 
4 874 
4874 
487% 
487% 
4 874 
487% 
Sunday 


Io 
II 
12 
13 
14 
T5 
16 
17 
18 


19 


Nov. 


I 
2 
3 
4 
5 
6 
8 
9 

10 

II 


12 
I3 
14 
15 
16 
17 
18 
19 
20 
21 
22 
23 
24 
25 
26 
27 
28 
20 


484% 
4 84% 


4 844 
4 84% 
4 84% 
4 84% 
4 8434 
4 84% 


RATES OF FOREIGN EXCHANGE 


TABLE V—Continued 


PostED RATES—BANKERS’ STERLING BiLtLts—Continued 


20 
ai 


Nov. 


313 


60 days Demand Nov. 60 days Demand 


484% 487% 30 Holiday 

484% 487% 

48434 487% Open4 84 48734 

48442 48732 High484% 487% 

484% 48734 Low 4 84 4874 

4 84 48734 = Last 4 84 4 87)4 
Sunday 

4 84 48734 

4 84 487% 

4 84 487% 

TABLE VI 


ACTUAL RATES—BANKERS’ AND COMMERCIAL BILLS 


60 Day 
4 8360-4 8370 
4 8360-4 8370 
4 8370-4 8380 
4 8365-4 8375 


4 8375-4 8380 
4 8375-4 8380 
4 8370-4 8380 
4 8370-4 8280 
4 8370-4 8380 


4 8370-4 8380 
4 8375-4 8385 
4 8375-4 8385 
4 8370-4 8380 
4 8370-4 8380 
4 8375-4 8385 


4 8365-4 8380 
4 8370-4 8380 
4 8350-4 8360 
4 8340-4 8350 
4 8345-4 8360 
4 8340-4 8350 


4 8335-4 8345 
4 8320-4 8330 
4 83 —4 8310 


posted rates. 


Bankers’ Bills 


Sight 
4 8680-4 8605 
4 8675-4 8605 
4 8690-4 8705 
4 8695-4 87 


4 8690-4 8705 
4 8695-4 8705 
4 8605-4 87 

4 8695-4 8705 
4 87 —4 8705 


4 87 -4 8705 
4 8695-4 87 
4 87 -4 8705 
4 87 -4 8705 
4 8690-4 87 
4 8690-4 8695 


4 8685-4 8690 
4 8670-4 8685 
4 8665-4 8670 
4 8660-4 8665 
4 8660-4 8665 
4 8670-4 8675 


4 8655-4 8660 
4 8635-4 8640 
4 8615-4 8635 


Cable 
Transfers 
4 8720-4 8725 
4 8720-4 8730 
4 8730-4 8745 
4 8735-4 8740 


4 8735-4 8740 
4 8735-4 8740 
4 8735-4 8740 
4 8735-4 8745 
4 8740-4 8745 


4 8740-4 8745 
4 8735-4 8740 
4 8745-4 8750 
4 8740-4 8745 
4 8730-4 8740 
4 8725-4 8730 


4 8710-4 8715 
4 8695-4 87 

487 -4 8705 
487 -4 8705 
4 8695-4 8710 
4 87 -4 8705 


4 8685-4 8690 
4 8665-4 8675 
4 8655-4 8660 


Commercial Bills 


On Banks 
482 -4 83 
482 4 83 
4 82 1/4-4 83 1/4 
482 4 83 1/2 


—4 83 3/8 
4 82 1/8-4 83 1/4 
4 82 1/8-4 83 3/8 
4 82 1/2-4 83 1/2 
4 82 1/4-4 83 1/2 


4 82 


1/8-4 83 3/8 
1/8-4 83 3/8 
1/8-4 83 1/2 
1/4-4 83 1/2 
1/2-4 83 1/2 
1/4-4 83 1/2 


4 82 
4 82 
4 82 
4 82 
4 82 
4 82 


4 82 1/8-4 83 1/2 
4 82 1/8-4 83 1/2 
4 82 1/8-4 83 3/8 
4 81 3/4-4 83 1/4 
482 4831/2 
4 81 3/4-4 83 


4 81 3/4-4 83 1/4 
4 81 3/4-4 83 1/4 
4 81 3/8-4 83 


Documents 
for Payment 
4 82 3/4-4 83 3/4 
4 82 7/8-4 83 7/8 


4 82 3/4-4 84 
483 —4 83 3/4 
483 4 83 7/8 
4 83 1/8-4 84 
A930 asod. 
483 -484 
483 -4 84 
483 4 84 
483 4 84 
483 484 
4 83 1/8-4 84 1/8 
483 4 84 
4 83 1/4-4 84 
ASF 2 4 84 
483 -4 83 7/8 


4 82 7/8-4 83 3/4 
4 82 7/8-4 83 3/4 
483 —-4 83 3/4 
4 83 1/4-4 83 3/4 


483 . -4 83 3/4 
4 82 3/4-4 83 1/2 
4 82 5/8-4 83 1/4 


It will be noted that the actual rates are consistently lower than the 


314 DOMESTIC AND FOREIGN EXCHANGE 


In reading articles dealing with foreign exchange, one frequently 
comes across such terms as “the spot rate,” “spot cables,” “spot 
sight,” “futures,” “forward transactions,” “forward discount rate,” 
“firm rates,” etc. The first three terms refer to the rates of exchange 
where immediate delivery is intended. “Future rates,’ “futures,” 
“future delivery,” “forward transactions,” “forward discount rate,” 
and “arrival discount rate,” all refer to the practice of the buyer or 
seller of exchange guarding himself against a possible unfavorable 
trend in the exchange or discount rates. If an importer has engaged 
a shipment of goods from abroad and will have to pay by means of a 
remittance of exchange three months hence, he can protect himself 
against an unexpected rise in the exchange rate by going to his banker 
and buying exchange for future delivery, but at a “future rate,” 
not at the rate then current in the market. The future rate quoted 
by the banker may be higher or lower than the current rate, depend- 
ing upon which way the banker thinks the market will turn. An 
exporter who has goods to ship, say a month hence, is likewise inter- 
ested in the exchange rates that will then prevail, because the returns 
which he gets from the sale of his drafts will depend on where the rates 
are at that time. In order to guard against unfavorable developments, 
and also to have a fixed or certain basis from which to calculate the 
value of his goods and thus more accurately to fix the prices to be 
charged the foreign customer, he may go to his banker and get him 
to quote a “future rate” at which he (the banker) will purchase the 
exporter’s bills of exchange a month hence. The banker quotes the 
exporter a “forward rate” or a “future rate,” and if satisfactory, a 
contract for a “future” or a “future delivery” is accordingly entered 
into. No matter where the market rate may be, the banker is bound 
by the rate quoted in the agreement. The “forward discount rate” 
is slightly different from the “futures” above referred to in that it 
concerns the rate of discount at which a bank agrees to discount drafts 
when presented by another bank at a future date. Say that a New 
York bank is approached by a large exporter and asked to buy a 
large amount of long bills on English banks or firms a month hence, 
i. e., the importer wants the New York bank to quote him a rate for 
future delivery. In order to be able to arrive at a satisfactory basis 
for the rate which it will pay, the New York bank must be assured 
of a definite rate of discount by its English correspondent or by an 
English discount house. English rates of discount vary from time 


RATES OF FOREIGN EXCHANGE 315 


to time, although normally they remain fairly stationary during any 
particular week because they are based‘on the official rate of the Bank 
of England, which as a rule is annowncéd every Thursday. The New 
York bank cables the London bank and asks it to quote a rate at which 
it will discount the bills in question a month hence. This “forward 
rate of discount,” or the discount rate at which the bills will be dis- 
counted a month hence on “arrival,” is cabled to the New York bank, 
and the latter is then able, definitely, to enter into a contract with the 
exporter as to the exchange rates at which it will purchase the bills for 
“future delivery.” No matter where the London discount rate is at 
the time the bills arrive, provided, of course, they arrive at the time 
agreed upon, the London bank is bound by its contract to discount 
them at the “forward rate’ previously stipulated.t The part that 
futures play in the exchange market will be more fully discussed in 
Chapter XIII. 

“Firm rates” are the prices set by a bank which has actually agreed 
to buy or to sell exchange at a definite rate, and are supposed to hold 
for a definite period. For example, New York bankers quote “firm”’ 
rates to their domestic correspondents at which the latter are au- 
thorized to draw bank drafts on foreign correspondents in connection 
with their sales of exchange. These “firm”’ rates are usually for a day 
only, although in normal periods, when the exchanges are practically 
stationary, they may hold for a week or until changed by subsequent 
notice. 

In quoting sterling exchange in our markets two methods of pro- 
gression are used. One, the older, progressses by one-eighth of a cent 
and is expressed as a fraction, while the newer, which is the more 
widely used, and which makes possible a little closer shading, pro- 
gresses by 5/1ooth of a cent and is expressed in the form of a decimal. 
Where the first method is employed the rate advances in the following 
manner: 4.86, 4.86 1/8, 4.86 1/4, 4.86 3/8, 4.86 1/2 etc., “one point” 
being one cent; but where the second method is followed the rate ad- 
vances by half a mill, as 4.8600, 4.8605, 4.8610, 4.8615, 4.8620, etc., 
“one point” in this case being not s5/r1ooth but 1/1ooth of a cent. 
At certain points the two scales coincide, as at 4.86 1/4 and 4.8625, 
or at 4.86 1/2 and 4.865, etc. 

We formerly quoted German exchange on the basis of the value of 
four marks in American money. The reason for this was that as the 


1 Federal Reserve banks are permitted to quote forward discount rates. 


316 DOMESTIC AND FOREIGN EXCHANGE 


mint par of the mark is approximately 25 cents ($.23831), four marks 
would equal about $1.00 (four marks at par being quoted as $.95284)., 
Thus in exchange books and tables published up to within a few years 
ago, mark quotations appear as the following: “M...95.5,” which 
means that four marks could be purchased for $.95 1/2. Progression 
under the old system was made by 1/16th of a cent. The rates would 
thus run 95 1/16, 95 1/8, 95 3/16, etc. In order to shade the quota- 
tions more closely the practice was followed of supplementing the main 
rate with the slight percentages of 1/16, 1/32, and sometimes 1/64, 
meaning 1/16 of one per cent, 1/32 of one per cent, etc. The quotations 
would sometimes appear, therefore, as 95 1/8-1/16, or 95 1/4 + 1/16, 
etc. Thus if we were desirous of knowing how much M.10,000 would 
cost at 95 1/4 + 1/32 per four marks, we would first find out how much 
they would cost at 95 1/4 cents per four marks. Then, after taking 
1/32 of one per cent of the result, we would add the latter sum to the 
total number of dollars first obtained. Thus, 95 1/4 ~ $.9525 for four 
marks. $.9525 divided by 4 equals $.238125 per mark. M10,o0co X 
$.238125 per mark equals $2381.25. 1/32 of 1 per cent of $2381.25 
equals $.74. $2381.25 plus $.74 equals $2381.99, which would be the 
cost of Mr1o,ooo at 95 1/4 + 1/32. If the supplemental fraction were 
minus 1/32, we would subtract the $.74 instead of adding it. On the 
other hand, when dollars were converted into marks at fractional rates, 
the sign that appeared before the supplemental quotation was reversed. 
For example to convert $10,000 into marks at 95 1/4 -1/32 we would 
find the cost of one mark by dividing 95 1/4 by 4, which would give us 
$.2381 (without carrying out the decimal). Dividing $10,000 by $.2381 
would give 41999.16 marks. 1/32 of one per cent of $10,000 is $3.125, 
which converted into marks at $.2381 per mark, would give 13.12 
marks. Adding 13.12 marks to 41999.16 marks would give the result 
of 42012.28 marks. If the supplemental fraction were a plus 1/32, we 
would subtract the 13.12 marks.’ The supplemental percentage 
fraction was usually applied to the dollars in the computation, not 
to the marks, although, as will be shown in Appendix III, the same 
results were obtainable by applying the supplemental percentage 
fraction to the marks and not to the dollars. 

By means of these confusing supplemental percentage fractions 
bankers were able to shave the quotations a little more closely than 
would otherwise have been possible. As Escher says: 


1 Other methods of conversion will be discussed in Appendix ITI. 


RATES OF FOREIGN EXCHANGE 317 


“On small amounts, two rates such, for instance, as 95 1/16 less 1/32 
and 95 plus 1/32 are practically the same, but where considerable sums 
are involved the difference is appreciable. By giving the arithmetic of 
the matter a little thought, it will plainly be seen that a fraction in the 
rate (which is less than 100) is a little more than the same fraction ex- 
pressed as a percentage (reckoned on 100). For example, convert M1oo,000 
at 95 1/16 less 1/32 and you get $23,758.20. At 95 plus 1/32 the result 
is $23,757.43. The first rate is higher than the second by 1/16 7m the rate, 
which is more than the 1/16 per cent which comes off,’’! 


All quotations of the mark ceased in the United States on or about 
March 28, 1917, and when resumed again in July, 1919, another 
practice, the quotation of what one mark is worth in our money, was 
adopted by American dealers.2, Thus today rates on Germany are 
quoted either as 1.3614 cents (1.365 cents) per mark, or as $.01365, 
progression in the former case being made by one-eighth of a cent 
($.001/8) and in the latter by no fixed amount.® 

The story of the franc quotation is somewhat similar to that of the 
mark. Until December, 1920, we quoted francs on the basis of the 
movable exchange, i. e., how many francs the dollar would purchase, or 
in other words, what was the dollar worth in terms of francs. The 
franc at par is worth $.19294, which would enable us at par to pur- 
chase 5.182 francs for a dollar. The situation was even further con- 
fused, as in the case of marks, by the addition or subtraction of supple- 
mental fractions representing percentages. Thus our quotations on 
Paris would run something like this: 5.18 1/2, 5.18 1/81/32, 5.16 1/4 + 
1/16, etc. Progression was by 5/8 of a centime (a centime being 1/1ooth 
of a franc), because 5/8 of a centime equals 1/8 of 1 per cent of a pound 
sterling, which made it easier to convert francs into pounds sterling 
for arbitrage purposes * than if some other method had been em- 
ployed. It is said that the reason for the latter practice arose from 
the fact that in early years practically all franc exchange was covered 
or paid for by means of sterling exchange. Brooks,’ however, assigns 
a different reason for this strange method of progression by saying 

1‘*Foreign Exchange Explained,” p. 35. 

2 Cf. Appendix III for examples of conversion on new basis of quoting mark exchange. 

’Sample quotations of mark exchange illustrating the latter method taken from the 
weekly tables of cable rates published by the Federal Reserve Board are as follows: .o1605, 
0158, .015825 for May 28, 31 and June 1, 1921, respectively. The reader can readily ap- 
preciate the fine shading made possible by quoting marks up to the thousandths of a cent. 


4 Cf. Ch. XIII for a discussion of Arbitrage. 
5 Op. cit., p. 114. 


318 DOMESTIC AND FOREIGN EXCHANGE 


that “as there are five francs to the United States dollar, 1/8 of 1 per 
cent on one franc would call for 5/8 of 1 per cent on five francs; be- 
sides, until recent years, 1/8 of 1 per cent difference in quotation was 
regarded sufficiently close for commercial purposes.” In the case 
of franc exchange, as was also true of mark exchange, the supplemental 
fractions represented a small percentage figured usually, though not 
always, on the basis of dollars involved in the computation. As will 
be shown in Appendix III, the same results could be obtained if the 
supplemental fractions were applied to the major franc quotation and 
not to the dollars. If we were calculating how many dollars we would 
have to pay for 5,000 francs at 5.16 1/4 —-1/16, we divided 5000 by 
5.16 1/4 which would give us $968.52, the number of dollars required at 
the major rate. We would then take 1/16 of one per cent of $968.52, 
or $.61, and subtract it from $968.52, which would give us $967.91. If 
on the other hand we were figuring how many francs we could pur- 
chase with $1000 at the rate of 5.16 1/4 -1/16, we would multiply tooo 
by 5.1625 which would give us 5162.50 francs. We would then take 
1/16 of one per cent of $1000 (not of 5162.50 francs), which would give 
us $.625. This then would have to be converted into francs at the 
given major rate, i. e., 5.16 1/4, and would equal 3.226 francs. This 
sum (3.226) would then be added to 5162.50, giving us the result of 
5165.726, or 5165 francs and 73 centimes. When converting francs 
into dollars we followed the sign by adding or subtracting the amount 
obtained in using the supplemental fraction, but when converting 
dollars into francs we reversed the sign and if the fraction were 
minus we added the amount obtained in using the supplemental frac- 
tion, but if the fraction were plus we subtracted the amount. This 
reversal of the sign was necessary because the plus sign made the franc 
cost more, while the minus sign made it cost less. Thus in changing 
francs into dollars with a plus fractional quotation (remembering 
that francs then cost more), we had to add the supplemental 
amount because it would cost more dollars; but in changing 
dollars into francs with a plus fractional quotation (still remem- 
bering as before, that the francs cost more under such circum- 
stances), we had to subtract the supplemental amount because we 
would get fewer francs per dollar.' Whitaker comments as follows 
upon one of the phases of this curious practice of using supplemental 
quotations: 


1See Appendix III for a further discussion of franc conversion methods. 


RATES OF FOREIGN EXCHANGE 319 


“To look a little further into the curiosities of this notation, we may 
explain that to place ‘minus 1/16’ after a rate brings that rate a little more 
than halfway towards the next cheaper main rate. Thus 5.19 3/8 less 1/16 
is a little closer to 5.20 than it is to 5.19 3/8. On the other hand 5.20 plus 
1/16 is a little closer to 5.19 3/8 than to 5.20! But the two rates, 5.19 3/8 
less 1/16 and 5.20 plus 1/16 are almost identical. The interval of 5/8 centime 
between the main rates is an interval of almost exactly 1/8 of 1%. Conse- 
quently an addition or subtraction of 1/16 of 1% to or from any main rate 
takes us almost exactly halfway to the next rate. In point of fact it takes 
us a shade beyond the halfway point.” } 


To avoid the complexities of the situation, H. K. Brooks unsuccess- 
fully urged the adoption of a plan of quoting francs and similar ex- 
changes with an interval of 1/8 of a centime.? Instead of progressing 
from 5.15 to 5.15 5/8, he suggested that progression be from 5.15 to 
5.15 1/8, then to 5.15 1/4, etc. The adoption of such a plan would have 
given practically the same results as were secured by the use of the 
confusing plus and minus fractional quotations. A change was bound 
to occur sooner or later, however, and in July, 1920, a number of New 
York banking firms agreed to abandon the old system of quoting 
francs, lire, drachmas, etc., as described above, and to adopt in its place 
quotations based on what the franc, lira, drachma, etc., are worth 
in American money, thus putting those exchanges on the same fixed 
or direct exchange basis as other foreign exchanges, excepting only 
the Canadian, which still was to be quoted on a premium and discount 
basis. As the result of further publicity, an announcement was made 
in November, 1920 by practically all the prominent exchange dealers 
in the United States that henceforth they likewise would follow the 
practice of quoting on the basis of fixed exchange. Progression in 
quoting francs is now made by one-eighth of a hundredth of a cent 
where fractional quotations are used, but where the decimal method 
is followed the shadings may at times reach four decimal places beyond 
the cents column.’ 

Rates of exchange fluctuate slightly in normal times and within 
certain well defined limits, but violently in times of panic or under 
the stress of war conditions. The accompanying chart (Chart I) and 


10>. cit., p. 95, footnote. 

2Op. cit., p. 115. 

3 Rates for cables on Paris for May 27, 28, 31 and for June 1 and 2, 1921, respectively, 
as published by the Federal Reserve Board, were .08245, .08345, .0829, .0847, .082725, 
the quotations signifying that franc cables were selling at slightly over eight cents per 
franc. 


320 DOMESTIC AND FOREIGN EXCHANG® 


table (Table VII) show the highest and lowest monthly quotations for 
sterling sight exchange for the two normal years, 1910 and 1913, 


TABLE VII 
HIGHEST AND LOWEST QUOTATIONS FOR SIGHT STERLING PER MONTH, 
1907, I9I0, I913 


1907 IQIO 1913 
Months Lowest Highest Lowest Highest Lowest Highest 
[AnUaEvic on cease 4.8440 4.8610 4.8615 4.8700 4.8570 4.8780 
February.......4.8440 4.8480 4.8600 4.8715 4.8720 4.8780 
March >. ee 4.8275 4.8470 4.8665 4.8780 4.8675 4.8800 
WADE LL vara eee 4.8365 4.8675 4.8760 4.8800 4.8625 4.8725 
DAR ah ee 4.8610 4.8700 4.8640 4.8780 4.8595 4.8680 
WONG ren ta eae 4.8655 4.8740 4.8585 4.8710 4.8635 4.8700 
uly eae ee ee 4.8655 . 4.8725 4.8520 4.8585° 4.8645" apaere 
ATISUSEs fae? oe 4.8625 4.8800 4.8525 4.8685 4.8575 4.8675 
September......4.8525 4.8625 4.8595 4.8675 4.8535 “Mapaeas 
OBOE. 1 eee 4.8240 4.8650 4.8570 4.8680 4.8500 4.8615 
November...... 4.8500 4.8875 4.8540 4.8620 4.8480 4.8565 
Becember ss si. 4.8410 4.8670 4.8475 4.8615 4.8500 4.8565 
sion seg ee My _Jur©e Ju) Sept Oct Nov Det 


SIGHT 
RATE 








SeaNehe 
SNELL 


peP Ss: 






Fa 
phe Se 
SVAN ei 
PA 

Af 


= | 












+--+ /902 


—— /9/0 





CuHart I 


Highest and lowest quotations for sight sterling 
monthly, 1907, 1910, 1913 


and for the abnormal year, 1907. The fluctuations of sight rates dur- 
ing the period of the World War and later are shown on Charts XIII,1 
XIV,? and XV.* It will be noted that in normal years the sight rate 
fluctuates well within what are generally known as the “gold export 
1P. 540. 2P. 541. 3P. 544. 


RATES OF FOREIGN EXCHANGE 321 


point” and the “gold import point,’ ! although this does not of neces- 
sity signify that no gold was being exported from or imported into 
the United States during those years. During the panicky year of 
1907 the fluctuations were very great. In any one month in the normal 
years of 1910 and 1913, it was unusual for the lowest and the highest 
quotation for sterling sight exchange to be more than one cent per 
pound sterling apart, although under conditions of stress and strain 
as in 1907 the lowest and the highest quotations of the month were 
from three to four cents per pound sterling apart. 

It is not only the rates of exchange between countries with different 
monetary systems that fluctuate from day to day. If all countries 
of the world were on the same monetary basis, rates of exchange would 
still vary as greatly as they do today with our multiplicity of monetary 
systems. As noted above in the case of Canada and the United States, 
and in the case of England, Australia, and South Africa, the countries 
in each group have the same coin for their standard unit of value, yet 
the rates of exchange fluctuate just as greatly and for the same causes 
as do those between countries not on the same monetary basis. 

The buying and selling rates of exchange depend primarily upon 
the relative bargaining power of the parties concerned although in 
the background a large number of factors are always at work influen- 
cing the rates in one way or another. The rates charged or paid by 
the small local dealers will usually depend in the first instance upon 
quotations which they receive by mail or by wire from the larger 
dealers. With these rates as a basis, the prices actually paid or charged 
will depend upon the amount demanded or offered for sale, the reputa- 
tion of the customer, what the traffic will bear, etc. In the case of 
the larger dealers, their opening rates in the morning will be fixed 
upon the basis of the closing rates of the day, before, the bids and offer- 
ings that come in by mail, wire, or phone before the office opens for 
business in the morning, cable advices received from abroad regarding 
the trend of rates in foreign centers, etc. The posted rates of the larger 
dealers will tend to be fairly uniform as is shown by the table of 
sterling rates on page 322 taken from the Commercial and Finan- 
cial Chronicle of December 31, 1910.2, Again, as is also true with 
the smaller dealers, the rates actually set for each transaction by the 

1Cf. Ch. XI, Gold and Gold Movements. 


2 This is the last date on which such tables appear in the Commercial and Financial 
Chronicle. 


322 DOMESTIC AND FOREIGN EXCHANGE 


TABLE VIII 


BANKERS’ POSTED RATES OF EXCHANGE 


Fri. Mon. Tues. Wed. Thurs. Ft. 
Dec. 23 Dec.26 Dec.27 Dec. 28 Dec.29 Dec. 30 


Brown Bros & Co. 60 days 4 83 83 83 83 83 
Sight 4 86% 86% 86% 86% |. 86% 

Kidder, Peabody & Co. 6bodays 4 83 83 83 83 83 

Sight 4 86 86 86 86 86 

Bank of British No. A. 60days 483% 83% 83 83 83 
Sight 4 86% 8614 86 86 86 

Bank of Montreal 60 days 483% HOLIDAY 83 83 83 83 

Sight 4 86% 86 86 86 86 

Canadian Bank of Com.60 days 4 83 83 83 83 83 

Sight 4 86% 86 86 86 86 

Heidelback, Ickel- 6o days 4 83 83 83 83 83 
heimer & Co. Sight 4 86% 86% 86% 86% 861% 
Lazard Freres. 60 days 4 83 83 82% 82% 82% 
Sight 4 86 86 85% 8514 854 

Merchants’ Bank 60 days 4 83% 83% 83 83 83 

of Canada Sight 4 86% 86% 86 86 86 


large New York houses will depend upon the amount involved, the 
reputation of the customer, what other firms are charging, etc. 

Behind the actual rates of the day, however, are those forces that 
tend to raise or to lower the quotation, which forces may be briefly 
summarized as: 


1. Supply of exchange. 

. Demand for exchange. 

. Length of time for which exchange is to run before payment, i. e., 
length of life of exchange. 

. The discount rate prevailing in foreign markets. 

. The standing or reputation of drawer and drawee. 

. The nature of the goods against which the drafts have been drawn. 

The amount of drafts that drawer has outstanding. 

. War or rumors of war, political developments, and other miscellaneous 
influences. 


& bd 


Cos AN f 


It must always be remembered that “foreign exchange rates are 
results of forces playing not only in the market where exchange is 
being bought, but also in the foreign market upon which it is being 
bought.” No market stands alone, uninfluenced by what is going on 
in other markets. Developments of all sorts in London, Paris, Berlin, 
South America, or the Orient affect the rates in the United States; 
and likewise developments in the United States affect the rates in 

1 Agger, op. cit. 


RATES OF FOREIGN EXCHANGE 323 


foreign centers. The corners of the foreign exchange market are 
knitted together into an unbelievably sensitive network, like the 
threads of a spider’s web. 

The two most important forces mentioned in the summary above 
are our old friends “Supply” and ‘‘ Demand,” each exerting a great 
influence upon exchange rates but in their turn being influenced by 
certain other factors. 

I. Supply of Exchange. (a) Considering first the element of supply, 
it is easily seen that the greatest source of bills of exchange is foreign 
trade transactions. When goods are shipped abroad and the ex- 
porter draws his draft on the buyer or on the financial agent of the 
latter as authorized by a commercial letter of credit, his draft 1m- 
mediately adds to the supply of exchange in the open market, pro- 
vided it is sold to some foreign exchange dealer. If, on the other hand, 
it is sent abroad for collection it has no influence upon the supply 
side of the market until it has been collected and added to the foreign 
account of the exporter or to the foreign account of the collecting bank. 
Then, to get the funds back home, drafts may be drawn and disposed 
of in the home market, or cables may be sold, both of which will in- 
crease the supply of exchange in the exporter’s country. 

According to the statistics of the United States government, there 
have been but three years since the Civil War when our exports have 
not exceeded our imports. The value of our merchandise imports 
and exports for 1909-1920 has been as shown on page 324. 

The statistics compiled by the United States Department of Com- 
merce do not include merchandise exported directly by our govern- 
ment, so that our excess exports have really been larger than as dis- 
closed by the above table. This huge excess of merchandise exports 
does not of necessity mean that it was all covered, or that a majority 
of it was covered, by the issuance of bills of exchange. A very con- 
siderable amount of our exports during the war and since that time 
has been sold against dollar credits which foreign countries have es- 
tablished in the United States. Beginning with the Anglo-French 
loan of 1915, it became the customary practice of the European 
countries to which we advanced funds, either through governmental 
or private loans, to use the monies thus made available in establishing 
“dollar credits” in the United States. These funds were deposited 
principally in New York for the account of the foreign countries, and 
whenever exports were forwarded, drafts were drawn in terms of dol- 


324 


DOMESTIC AND FOREIGN EXCHANGE 


TABLE IX 


MERCHANDISE Exports AND Imports, UNITED STATES, 1909-1920! 


Excess of Exports 


Year ended— Total Exports Imports over Imports 

June 30: 
TOOQ miele sever ey 1,663,011,104 1,311,920,224 351,090,880 
TORO ey eek eed 1,744,984,720 1,556,947,430 188,037,290 
TOLY RS Ae adasatont 2,049,320,199 1,5273220,10% 522,094,004. 
TOLO ike cee 2,204,322,409 1,653,264,034 551,057,475 
IQI3 te bie nts 405,004,140 1,813,008, 234 652,875,915 
QA scree saat 2,364,579,148 1,893,925,057 470,653,491 
TOUS 4 rae a ee 2,768,589,340 1,674,169,740 I, 094,419,600 
1010; Vann era 4,333,482,885 2,197,883,510 2,135,599,375 
TOL? tee eee 6,290,048,394 2,659,355,185 3,630,693,209 
IOIS. 55 tee a 5,919,711,371 2,945,055,403 2,974,055,968 

Dec 3x: 
1918 (6 mos.)... . . .3,174,860,935 1,485,208,776 1,689,652,159 
TOLOs eee 7,920,425,990 3,9004,364,932 4,016,061 ,058 
TOLO< ae Feet ee 8,228,016,307 5,278,481,490 2,9049,534,317 


lars against those dollar credits. As a consequence, the foreign ex- 
change market was not affected by the drawing of those drafts any 
more than it would have been affected by a Chicago merchant drawing 
a draft on a New York bank, although as a result of the drawing of 
those dollar drafts the exchanges of the Allies were relieved from the 
great weakening pressure of a mass of foreign bills that otherwise 
would have been drawn, thereby enabling those exchanges to be 
maintained during the war at a level that did not truly represent their 
real value. It must not be surmised, however, that this was the only 
means that was employed to stabilize the exchange rates of the Allies; 
others will be discussed in subsequent chapters. 

During normal times exports from the United States to foreign 
countries predominate during the fall and winter months, for it is 
then that we ship large amounts of raw materials, such as grain, cotton, 
etc., chiefly to the European countries. During those months, there- 
fore, a large number of drafts are drawn against exports, and exchange 
rates normally tend to weaken. Looking at the matter from the stand- 
point of an Englishman, Clare in his “A. B. C. of the Foreign Ex- 


1 Statistical Abstract of the United States, 1920, p. 397. 


RATES OF FOREIGN EXCHANGE 325 


changes” ! states that: “Owing to the magnitude of our imports from 
the States, the creation of bills in connection with the shipments of 
corn and cotton, &c., in the Autumn is so great as almost invariably 
to turn the exchange against us from about August until December, 
but during the rest of the year it is mostly in our favor, and as a rule 
attains its maximum about April, that is to say, after the whole of the 
old crops have been paid for and before drafts have been offered in 
anticipation of the new.” 

(b) A second source of the supply of exchange has to do with the 
sale of American securities to residents of other countries. When we 
sell stocks or bonds to foreigners, the ordinary practice is for a draft 
to be drawn against the buyer and sold in the New York market, 
usually with the securities attached as collateral. Such drafts neces- 
sarily add to the supply of exchange. Before the war enormous 
amounts of American securities were sold and held abroad. Sir George 
Paish in his report to the United States National Monetary Commis- 
sion in 1908 estimated that the amount permanently invested by 
foreigners in United States securities was approximately $6,000,000,- 
000, apportioned as follows: Great Britain, $4,500,000,000; France, 
$500,000,000; Germany, $1,000,000,000; Holland, $750,000,000.? 
Although the floating of new securities in the American market does 
not of necessity weaken the exchange rates on those countries whose 
citizens are heavy investors therein, nevertheless there is a very 
decided tendency in that direction, especially in times of active 
financing. For example, in May, 1895, exchange rates were demoral- 
ized during the first half of the month as a result of the offering of a 
large supply of drafts which had been drawn in connection with the 
foreign purchases of our securities. Inevitably exchange rates de- 
clined, although subsequently when foreign purchases eased off con- 
siderably the market became firmer. In October, 1913, the sale of 
$5,000,000 Interborough Rapid Transit bonds was one of the important 
causes that produced a decline in sterling rates. Hundreds of other 
instances might be cited. It sometimes happens that instead of the 
securities of a new concern or the new issues of an cider firm being 
floated only in the United States, a large block of such stocks and 
bonds will be sent abroad by the trust company, syndicate, or invest- 


1Pp. 135-136. 
2 Trade Balance of the United States,” 61st Congress, 2nd Session, Senate Document 
579, PP. 174-175. 


326 DOMESTIC AND FOREIGN EXCHANGE 


ment house that is underwriting the issue, and disposed of in European 
markets, the financial returns therefrom being added to the foreign 
bank account of this underwriting agency. These increased foreign ac- 
counts merely signify that an added amount of foreign exchange is 
thereby made available. Itis not unusual for the foreign funds thus 
accumulated to be brought back to the United States through the draw- 
ing of drafts against such deposits, and at times their sale in the Amer- 
ican market materially weakens the exchanges. In August, 1908, to 
cite one of the many instances, exchange became extremely heavy 
(the lowest rates existing on August 25th, when sight sterling sold at 
4.8570 and cables at 4.8585), caused in part by the gradual recall 
from Europe, through sight sterling and cable transfers, of bankers’ 
balances and credits representing the proceeds of securities negotiated 
abroad during the preceding months. It was estimated that about 
$30,000,000 was availed of in that manner at that time, the funds in 
question representing the proceeds from the sale abroad of securities 
of the National Railroads of Mexico, the Pennsylvania Railroad, and 
certain other corporations, the returns from which had been tem- 
porarily loaned in London, Paris, and other financial centers. 

(c) A third factor affecting supply has to do with the money rates 
at home and abroad. If money rates are high in New York and low 
elsewhere, it necessarily implies that American bankers much prefer 
to have the use of their money at home rather than abroad.! In order 
to bring their funds home, they will draw drafts on their foreign ac- 
counts and sell such drafts in the open market, thus adding to the 
supply of exchange and tending’ to reduce the rates. Not only do 
high money rates at home and low money rates abroad influence the 
transactions of American bankers, but they also cause foreign bankers 
to place their money in the American market. This is done by their 
requesting American correspondents to draw drafts on them, to sell 
those drafts, and to loan in the American market the funds thus ob- 
tained, so as to receive the prevailing higher money rate.? At times 
the money rate may be higher in one foreign center than in another, 
whereupon the American banker withdraws his account from the 


1In August and September, 1906, low discount rates abroad and the demand for funds 
in the United States at high rates caused a mass of finance bills to be drawn by American 
bankers. : 

2 For example, in November, 1913, when the money market abroad stiffened and ease 
developed at home, exchange rates advanced, but when firmness in money rates occurred 
here, exchange rates declined. 


RATES OF FOREIGN EXCHANGE 327 


lower money market and forwards it to the higher money market. 
The American banker effects this by selling a draft on his own account 
in the lower money rate center and buying with the funds thus ob- 
tained, a draft or cable on the higher money rate center. The draft 
or cable is forwarded abroad and the proceeds credited to his account. 
The first draft, or cable, i. e., the one which he has sold, will add to 
the supply of exchange on the low money rate center and, as a result, 
other things being equal, will have the effect of tending to weaken 
exchange rates on that point. The purchase of the draft or cable by 
which he remits to the other country will have the effect of increasing 
the demand for exchange on the country to which his funds are being 
transferred, and consequently will tend to increase or strengthen the 
exchange rates thereon. If, on the other hand, he cables his corre- 
spondent in the low rate center to purchase exchange and forward it 
to the high rate center, his cable in itself has no effect upon the ex- 
change rate on either center, although the shifting of his account 
to the high money center will affect the demand for exchange on that 
center in the country from which his account is being shifted. When 
his account is finally in the high money rate center, it will add to his 
supply of exchange in that center, and will tend to weaken the ex- 
change rate thereon. 

The existence of high money rates in the United States and low 
money rates abroad, when linked with high exchange rates in the 
United States on foreign centers, will induce American bankers to 
issue finance bills in order to take advantage of the high exchange 
rate and also the high money rate at home. The sale of their finance 
bills provides them with the funds which they loan out in the home 
market, thus increasing the available money supply and tending to 
reduce money rates. Also, strangely enough, the very issuance of 
their finance bills creates a supply of exchange which in itself tends to 
weaken the exchange rate on the foreign center against which the finance 
bills have been drawn, thus enabling cover to be purchased sooner or 
later at lower rates, provided no unexpected developments occur to af- 
fect the situation adversely. Thus high money ratesand high exchange 
rates bring forth a flood of finance bills which exert a weakening in- 
fluence upon the exchange market and also upon the money market, 
and so tend to reduce both the rate of exchange and the money rate, 
unless other counteracting influences appear in the market." 


1Cf. p. 347, for discussion of the effect of the foreign discount rate on rates of exchange. 


328 DOMESTIC AND FOREIGN EXCHANGE 


(d) Fourthly, we have that group of miscellaneous activities that 
bring forth a supply of exchange. Americans render all sorts of ser- 
vices to foreigners and in order to be reimbursed draw drafts on them. 
There are also those who have payments due them from abroad in 
connection with dividends, interest, maturing loans, brokerage charges, 
insurance commissions, repair work on foreign vessels, consular ex- 
penses, etc., and who draw drafts on their foreign debtors. 

Another matter that must not be overlooked in this connection is 
the interest payments on the loans which we have extended to foreign 
nations during and after the World War as well as the interest pay- 
ments on our investments in foreign municipal and corporation bonds. 
The total amount of foreign government, state, city, and corporation 
loans floated in the United States and outstanding on July 1, 1920, 
aggregated more than $12,000,000,000.1 As 1921 came to a close 
the accrued interest owing on that sum totaled over one billion dollars. 
When interest payments on such loans are made, it is necessary for 
the foreign borrower (private party or government) to build up dollar 
credits in the United States. A means to this end is the purchase of 
American exchange in the foreign market, which makes the dollar 
more valuable in that market, i. e., able to command more of the foreign 
money unit, which weakens the value of the foreign money unit in 
our market. Another means is the sale of foreign drafts in our markets, 
which adds to the supply of exchange available on those countries and 
which has the same weakening effect on the exchange rates. The 
volume of these forthcoming interest payments is so large as to be 
almost unbelievable. Great Britain’s annual interest debt to our 
government for funds advanced to her during the World War amounts 
to $209,840,000. The aggregate annual interest debt of the Allied 
Governments to the United States totals $475,000,000. We have 
permitted Great Britain to suspend interest payments until 1922, 
and it is now proposed that the interest payments of all the Allies be 
deferred for a period of at least fifteen years. This proposal in actu- 
ality would result in the creation of a loan to them of approximately 
$7,000,000,000 in addition to the $9,000,000,000 which we have 
already advanced. 

When these public and private loans mature, they may be paid off 
out of funds made available (a) by means of drafts drawn on the 
Allies by their American agents, or (b) by the Allies forwarding us 


1 Cf. p. 333. 


RATES OF FOREIGN EXCHANGE 329 


dollar exchange, or (c) by gold shipments. Any of these methods 
will necessarily result in a weakening of the exchange rates on the 
countries concerned and in the strengthening of the position of the 
dollar, provided, of course, no other outstanding developments occur 
to offset the influence of the great demand for dollar exchange and the 
creation of such a large supply of foreign exchange. The most impor- 
tant of the foreign loans paid off thus far has been the outstanding 
balance of the Anglo-French loan of $500,000,000, floated in 1915 and 
maturing October 15, 1920. About $200,000,c00 was involved in the 
payment made on the latter date, being largely the share of the French 
government in the loan. The Commercial and Financial Chronicle of 
October 16, 1920, stated that the remaining amount of the bonds had 
been retired somewhat earlier through their purchase in the open 
market or in other ways, a considerable number being accepted in 
payment of subscriptions to the $100,000,000 French loan which had 
just previously been floated by an American syndicate. The Chronicle 
declared that the funds to meet the maturity had been raised by 
Great Britain and France by various methods, including operations 
in the exchange market, sale of American securities, gold shipments, 
and the placement of the above mentioned French loan. The trans- 
action was handled most cautiously so as not to disturb the money 
market, most of the required funds as they were accumulated being 
loaned on call in the New York market and then very gradually called 
in before the day of payment. In July, 1921, however, as the result 
of a similar situation, not so carefully handled, sterling exchange dis- 
played sensational weakness, falling from 3.735 on July 1 to 3.55 3/8 
on July 29. While the chief weakening influence was the continued 
offering of commercial bills drawn largely against future shipments 
of grain and cotton, yet a powerful element in the situation was the 
sale of sterling bills by prominent British interests for the purpose 
of accumulating dollar credits in anticipation of the payment in the 
United States of the maturing British notes.’, 

Considering our foreign loans, the interest payments thereon, our 
huge excess exports, etc., it is difficult to see how in the future any 
very great strength can be evidenced by the foreign exchanges in our 
market, even after the leading nations of the world return to a gold 
standard basis. This statement does not mean to imply that the 
foreign exchanges will remain for any length of time as greatly de- 

1 Commercial and Financial Chronicle, Bank and Quotation Section, August, 1921, p 16. 


330 DOMESTIC AND FOREIGN EXCHANGE 


preciated as they are at present, but that when conditions do return 
to normal the exchanges will be very apt to fluctuate between the 
gold import point and the par of exchange rather than between the 
gold import point and the gold export point.! 

Ordinarily, American offices of foreign insurance companies keep 
sufficient funds on hand to meet losses as they occur, but in times of 
widespread disaster, such as the Baltimore and San Francisco fires, 
they are compelled to get funds from their foreign home offices, which 
they do by drawing drafts against the latter and selling them in the 
American market, an operation that tends to weaken exchange rates 
by greatly increasing the available supply. 

Exchange offered for sale in connection with arbitrage operations 
and speculative transactions * must also be included as “Supply.” 
Both arbitrage and speculation are common activities in normal 
times, but during the World War arbitrage practically ceased, while 
speculation became rampant, even among those who were ignorant 
of the simplest features of foreign exchange. Again and again specu- 
lative interests have been in control of the market. During 1921 when 
the mark registered such startling declines, millions of marks were 
dumped onto the market by speculators who hoped to avoid greater 
losses as a result of a further decline in the mark quotation. This 
dumping process helped to force the rate even lower than it would 
otherwise have gone. 

An increasingly large number of travelers, both for pleasure and 
for business, have come to the United States in these later years, 
bringing with them travelers’ checks or travelers’ letters of credit. 
Travelers’ checks or drafts against travelers’ letters of credit, being 
payable by the foreign issuing bank or dealer, add to the claims of 
American banks on foreign institutions and result in an increase 
in the amount of exchange available on foreign countries. 

(e) Finally, at times when it pays American bankers to export gold, 
it is the custom, as will be seen in Chapter XI, for drafts to be drawn 
or cables to be sold against the gold as soon as shipped. Gold is 
usually exported in fairly large sums, and the resulting drafts or cables 
necessarily tend to weaken the exchange rate. It is this same weaken- 
ing influence of gold exports, as will be seen in Chapter XI, that in 
normal times tends to bring the exchange rate again below the gold 
export point. 

1Cf. Chapter XI. 2Cf. Chapter XIII. 


RATES OF FOREIGN EXCHANGE 331 


II. Demand for Exchange. (a) The demand for exchange is influ- 
enced by an equally large number of independent factors, the most 
important undoubtedly being the need for exchange instruments of 
various sorts with which to pay for imports of merchandise. Although, 
as we have seen in earlier pages, our exports have greatly exceeded 
our imports for many decades past, it is necessary for us to pay for 
imports just as we expect to receive payment for our exports. Ameri- 
can firms who import from all parts of the world are continually in 
the market for exchange with which to pay their foreign creditors. A 
matter frequently overlooked in this connection is that a considerable 
amount of our imports coming from all parts of the world has been 
and will probably continue to be financed under sterling letters of 
credit.' When the foreign exporter draws his drafts on a London 
bank under a sterling letter of credit sent to him by an American im- 
porter, his drafts create a supply of exchange on London in his coun- 
try. These drafts have to be met in London when they mature, and 
consequently add to our indebtedness to England. We then pay by 
remitting sterling drafts to London as “cover,” thereby creating a 
demand for sterling exchange in the United States. 

(b) In earlier pages we have seen that the sale of securities to for- 
eigners creates a supply of exchange; conversely, when we purchase 
securities from them, our payments, being made by means of bills of 
exchange, increase the demand for exchange. A serious decline in 
the prices of securities often induces foreign holders to unload on the 
American market, although it is not unusual for high prices of securi- 
ties to induce them to sell to us so as to reap the gains. We remit 
exchange to pay for the securities that we purchase. During times of 
stress and strain in the financial world we have always bought back 
large amounts of foreign-held securities. During the panic of 1893, 
partly as a consequence of the fear aroused at that time by the growing 
demand for a bimetallic standard in the United States, foreign hold- 
ings of stocks and bonds were dumped onto the American markets. 
Rates of exchange ruled high during the first six months of 1893 
partly because of that fact and partly because our imports of mer- 
chandise were unusually heavy with an accompanying light export 
of domestic merchandise. Again, during the early weeks of the panic 
of 1907, millions of dollars worth of foreign-held securities were un- 
loaded on the American stock exchanges, and as a result of the great 


1In England, frequently called ‘“‘reimbursement credits.” 


332 DOMESTIC AND FOREIGN EXCHANGE 


demand for exchange with which to remit, rates rose to what were 
their record levels, cables selling at one time for 4.91. During the week 
ending February 27, 1909, a demoralizing decline in United States 
Steel, Reading Railroad, and other stocks occurred, and a continued 
selling by foreigners ensued with a resulting demand for exchange 
which exerted a stiffening influence on the exchange market. Again, 
at the beginning of the World War we had the same sort of situation 
arising, but from other causes. On July 24, 1914, Austria forwarded 
her ultimatum to Serbia. The stock exchanges of the world closed 
between July 27 and July 31. The New York exchanges remained 
open until the 31st, while liquidation went on at an amazing rate from 
all parts of the world, necessarily producing startling declines in the 
prices of securities. New York investment houses had such a heavy 
list of orders to sell that had they been able to negotiate all of them 
the results would generally have been disastrous. The unprecedented 
demand for foreign exchange with which to make remittances caused 
sterling demand drafts to rise to 5.50 on July 31, while cables went 
to 6.35. Sterling demand drafts and cables rose to still higher levels 
within a few weeks, but for additional causes. 

As the war progressed, and partly as a consequence of the methods 
pursued by England in stabilizing sterling exchange in the United 
States,! it became possible for us to buy back large blocks of American 
stocks and bonds. In the latter part of March, 1917, Mr. L. F. Loree, 
President of the Delaware and Hudson Railway Company in announ- 
cing the results of an exhaustive study which he had made concerning 
the return of European-held securities stated that we had, up to that 
time, purchased over 56.15 per cent ($1,518,000,000) of the total 
amount of American railroad securities which had been held abroad. 
It is impossible to estimate accurately the total sum which has been 
purchased since 1914, but it is claimed by many authorities that it 
is approximately $4,000,000,c00 and that a relatively small amount 
still remains in foreign hands. 

Concomitantly we have been investing heavily in the stocks and 
bonds of foreign corporations as well as in the bonds of foreign cities 
and foreign countries. These investments have taken the shape of 

1 As will be described more in detail in Chapter XIV, England bought or borrowed 
American securities held in England and sold them through Morgan & Co. in New York 
at those times when sterling rates fell below the pegged position of 4.76. The money realized 


from such sales was used to purchase cables on England, thus artificially strengthening 
sterling in our market and causing it to rise again to 4.76. 


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334 DOMESTIC AND FOREIGN EXCHANGE 


loans of huge proportions to the Allied Governments made by the 
United States government for the purpose of prosecuting the war 
against Germany, and investments by individuals and financial houses 
in the bonds of foreign cities and nations ' and in the stocks and bonds 
of corporations of various kinds in all parts of the world, totaling 
far in excess of $12,000,000,000. ‘The data regarding our loans out- 
standing July 1, 1920 are shown in Table X (page 333), compiled by 
the Guaranty Trust Company of New York. 

The above tabulation does not include subscriptions in the United 
States to foreign internal loans, as the amounts of such subscriptions 
are not available, nor does it include the following issues: “(z) Mexican 
loan of $25,000,000 (U. S.) 4 per cent bonds (of a total issue of $40,000,- 
ooo), due in 1954; (2) two Cuban government loans, one of $35,000,000 
gold 5 per cent bonds, dated March, 1904, and due March 1, 1944, and 
one of $16,500,000 external 41% per cent bonds dated August 2, 1909, 
and due August 1, 1949. These issues were placed partly in the United 
States and partly abroad, but the amounts placed in this country 
are not available.” 2 From July 1, 1920, to December 31, 1921, we 
floated an additional amount of foreign government, state, and munic- 
ipal loans totaling $610,579,300.2 No data are available as to the 
amount of our investments in foreign corporations since July 1, 1920.4 

The larger part of our loans to foreign cities and nations has been 
in the form of cash advances and dollar credits established in the 
United States, which could have no immediate effect upon the rate 
of exchange except through reducing the supply of exchange on those 
countries. Later, however, when the loans are paid off or when interest 
payments are made, it is evident that foreign exchange rates will 
inevitably be weakened.’ Some of the loans, however, and the greater 
part of our investments in corporation and foreign municipal securities 
made during and after the World War, have necessitated the remitting 
of the funds so invested and have therefore aided in sustaining the 
demand for exchange on those countries. The heavy investment 


1T. W. Lamont of J. P. Morgan and Company stated in March, 1922, that out of a total 
of $2,587,3909,000 European government obligations floated in this country from August 1st, 
1914 to January 1, 1922, only $818,000,000 remained at that time in private hands. The 
amount held by bankers was declared to be negligible. Commercial and Financial Chron- 
icle, March 4, 1922. 

2 Federal Reserve Bulletin, July, 1920, p. 687. 

3 New York Journal of Commerce and Commercial Bulletin, January 3, 1922. 

4The Federal Reserve Bulletin of April, 1922, states that during 1921 and down to 
March, 1922, we had floated foreign loans aggregating $913,303,000. 

5 Cf. p. 320. 


RATES OF FOREIGN EXCHANGE 335 


(speculative in character) of Americans in German municipal bonds 
immediately following the war undoubtedly held the mark at a higher 
level than would otherwise have been the case. In September, 1921, 
the floating in the United States of a $25,000,000 loan to Brazil and 
one of $50,000,000 to Argentina had the effect of strengthening the 
exchanges not only of those two countries, but of practically all of the 
South American countries as well.! 

Excluding the large war advances which our government made 
to the three important Allies, Great Britain, France, and Italy, our 
heaviest investment thus far has been in Canadian loans of various 
kinds. Commenting on this matter, the Bankers’ Trust Company 
of New York, in a statement issued December 6, 1920, declared: 


“Prior to 1914, Canada secured in Great Britain the greater part of the 
capital required to develop her natural resources. The war immediately 
dried up the wells from which flowed this vivifying supply. In fact the 
current was reversed and Canada gave back to the mother country many 
millions of capital. 

“Then it was that Canada turned to the United States for the capital 
no longer to be obtained overseas. The result is that in the past six years 
we have loaned Canada nearly a round billion of dollars. This money 
has gone to help Canada meet her military expenses, to help her finance 
her exports of wheat and other foodstuffs and of munitions of war. 

‘“‘A large amount has been invested in American owned factories because 
on account of Canadian tariff regulations it is more profitable to manufac- 
ture certain classes of goods to be sold within her borders rather than to 
export them to her. Again we need paper pulp and paper and Canada 
has in abundance the raw materials to produce them if we will turn them 
into the manufactured product on her side of the boundary line. 

“But this is not done at a loss. On the contrary, our interest and profits 
received from our Canadian investments are estimated to have been, during 
the past six years, around $330 million while Canadians have probably 
paid us over $90 million in freight money, insurance and the like. There- 
fore, of the approximately one billion dollars which we have invested in 
Canada in recent years, nearly half represents merely a reinvestment of 
payments made to us by our Canadian friends.” ? 


Demand for exchange also arises in connection with the payment 
of maturing American corporation and municipal loans held abroad. 


1Commercial and Financial Chronicle, Bank and Quotation Section, October 8, 1921, 


p. 17. 
2 Commercial and Financial Chronical, December 11, 1920. 


330 DOMESTIC AND FOREIGN EXCHANGE 


Before the World War a large share of the securities of American cor- 
porations was floated abroad.' It was not unusual for corporations 
to issue bonds, the principal and interest of which were made payable 
to foreign holders, either in gold or at a fixed rate of exchange. When 
payments are made the corporation goes into the market and pur- 
chases exchange with which to make remittance, thus helping to 
strengthen the rate. The same holds true in the case of maturing 
city loans. To cite a concrete instance:—it had for some years been 
the practice of New York city to sell its tax warrants‘ in foreign 
countries, principally in France and England, because it could get a 
larger return therefor than when sold in the United States. At the 
outbreak of the World War, New York City owed about $82,000,000 
on foreign-held tax warrants, payable in gold. A syndicate of bankers 
was organized to finance the city’s demands, and subsequently re- 
mitted $80,243,941 in exchange, not to mention certain gold shipments. 
The demand for such a large amount of exchange increased the pres- 
sure upon the market and aided in raising the rates on England and 
France.* 

The part played by the international dealings in stocks and bonds 
(both civil and corporation) can hardly be overestimated so far as their 
effect on the exchange and financial markets is concerned. The ramifi- 
cations of such transactions and their importance in the financial affairs 
of a country are seldom appreciated by the layman or by the ordinary 
exchange dealer. 

(c) In the past it has been necessary for us to remit, usually semi- 
annually, large payments of interest and dividends upon stocks and 
bonds held abroad. Those payments have been variously estimated 
as totaling from $200,000,000 to $300,000,000 per year. Every half- 
year the mail sacks coming from foreign countries would be bulging 
with clipped coupons being forwarded to us for payment. Since we 
had to remit payments to our foreign creditors by means of bills of 
exchange, the rates on foreign countries always showed a tendency 
at those times to increase. Inasmuch as since the war we have bought 
back the greater part of these European-held securities, it may be 
years before our payments of interest and dividends will again play 

1It has been estimated that the aggregate amount of British capital invested in the 
United States in August, 1914, was about $3,888,000,000. 

2 Short time obligations secured by the forthcoming tax income of the city, and used 


by many cities as a means of anticipating future revenue from taxes. 
A ts Re KE (oP 


RATES OF FOREIGN EXCHANGE 337 


such an important part in our foreign exchange market. In fact our 
country has within the last few years become a creditor nation and has 
invested heavily in loans to European governments, cities, and cor- 
porations, not to mention the investment of much American capital 
in South America and in the Orient. The Europeans, however, es- 
pecially in neutral countries, are still active in the market as pur- 
chasers of American securities, as is evidenced by a late report from 
The Hague, appearing in the New York Times of November 3, 1920, 


to the following effect: “. . . big capitalists are sending enormous 
sums to America and steadily buying scores of millions of dollars of 
American securities. . .. The Dutch feel that America is the one 


place safe from Bolshevism and other social disturbances and are in- 
vesting largely in American securities. Even the small farmers who 
grew wealthy during the war favor those securities. Bankers in small 
provincial towns say that they invest millions of dollars monthly.” 
The to-be-expected result of such heavy purchases by the Dutch was 
a sudden fall in the rate for guilders which had for so long been steadily 
maintained in our market. Later, however, as we remit interest and 
dividend payments to the Dutch, the increased demand will tend to 
raise the rate of exchange on Holland. 

(d) Each year large amounts of money are sent abroad by immi- 
grants to relatives and families, remittance almost always being 
made by means of some kind of exchange. The extent of such remit- 
tances is not definitely known but it has been variously estimated 
at from $100,000,000 to $150,000,000 a year. As showing the extent 
to which immigrants are an influence on the demand side of the foreign 
exchange market, it is interesting to note that during 1919 the Italians 
in the United States sent to their home country 432,692,497 lire * in 
addition to the savings which some 75,553 returning immigrants 
carried back with them.? The American Consul General at Athens 
estimated that during the same year the Greeks in the United States 
remitted approximately 350,000,000 drachmas.* It has been stated 
that English and Irish immigrants remit about $25,000,000 a year to 
friends and relatives in Great Britain. 


1 Approximately $83,509,651 when computed at 19.3 cents per lira. The lira at par is 


19.294 cents. 
2Statement issued by the U. S. Department of Commerce, Commercial and Financial 


Chronicle, October 9, 1920. 
8 This amounts to $67,550,000 when figured at 19.3 cents per drachma. The drachma 


at par is 19.294 cents. 


338 DOMESTIC AND FOREIGN EXCHANGE 


(e) Another element that looms large as a factor in the demand for 
exchange concerns itself with the annual remittances which we have 
for many years been compelled to make to England and a few of the 
Continental countries for insurance premiums and ocean freight 
charges. From 1791 to 1820 our imports exceeded our exports by more 
than $500,000,000. We paid for that relatively vast importation by 
rendering a shipping service to foreign nations. For many years 
past, however, our exports have greatly exceeded our imports and in 
part payment of the difference foreign countries have rendered us a 
shipping service, carrying our ocean freights and exacting a charge 
therefor variously estimated at from $20,000,000 to $40,000,000 per 
year. During the World War, however, the unusual conditions that 
existed made possible the sudden expansion of the American merchant 
marine; European-owned ships were being kept busy carrying supplies 
and troops for the warring nations. But since the signing of the 
Armistice it has been increasingly difficult for American ships to com- 
pete successfully with European and Oriental vessels. It is impossible 
at this writing to say what the outcome of the present struggle on the 
high seas will be. If American capital can make more money on the 
water than it can by investing in enterprises on the land, either with 
or without a subsidy, our merchant marine will remain an active and 
powerful factor in the world’s carrying trade; otherwise not. Foreign 
competition is bound to be severe, especially between the United 
States, England, and Japan. 

Before the war practically all of our marine risks were insured in- 
foreign companies, mostly British. A great deal of life, fire, accident, 
and liability insurance was and still is carried in English and Con- 
tinental companies. Dr.5S.%. Heubner, Professor of Insurance at the 
University of Pennsylvania, estimated that in 1918 the insurance 
premiums which Americans paid on policies with foreign companies 
amounted to approximately $250,000,c00. Although the American 
offices of these companies usually keep a large amount of reserve 
funds on hand or invested in American securities, nevertheless the 
greater share of the premiums is sent abroad by means of exchange 
purchased in the open market, which of course increases the demand 
for exchange and tends to strengthen the rate. During the war a large 
amount of insurance of all kinds, including quite a bit of marine 


1 Escher, “‘Elements of Foreign Exchange,” p. 21, approves an estimate of $150,000,000 
per year. 


RATES OF FOREIGN EXCHANGE 339 


insurance, was written by American companies, and since the Armistice 
a serious effort has been made to retain the business so lately won. 
This state of affairs has naturally resulted in a lighter demand for ex- 
change with which to pay premiums abroad. 

(f) Europe has always been a favored land of travel for American 
tourists, and many a city on the Continent survives solely or mainly 
on the funds which our citizens take into those communities. Before 
the World War it was estimated that our tourists were in the American 
markets each year for from $200,000,000 to $500,000,000 in exchange 
to carry abroad with them. The effect of this recurring and fairly 
steady demand was always evident in the market. During the war, 
however, our tourists remained at home, and the lack of demand for 
such a large amount of exchange aided in weakening the rates on 
European countries. 

(g) There are also a number of American families living temporarily 
or permanently in foreign countries to whom funds must be sent 
occasionally or at regular intervals. Nor must we overlook those 
instances in which American heiresses have wedded English and 
European husbands, making it incumbent on us to remit millions of 
dollars as dowries or as income from American-owned properties. As 
Withers facetiously remarks, “We (England) draw on the United 
States for the ‘dowry drain’ and repay it with affection and social 
distinction conferred on American heiresses by their English hus- 
bands.” ? 

(h) Before the World War there was also a great demand for ex- 
change with which to meet our maturing currency and sterling loans 
and finance bills. These long bills were customarily drawn so as to 
fall due in the autumn, at which time exchange rates on foreign coun- 
tries were usually at their lowest levels.2 Had it not been for the 
autumnal demand for exchange with which to pay off the millions 
of dollars of such long bills issued during the spring and early summer 
months, the rates of exchange every fall would have reached con- 
siderably lower levels. To cite an instance of the effect of finance 
bills on the rates of exchange: In October, 1912,a mass of American 
securities was thrown onto our markets following the declaration 
of the Balkan War. To obtain the funds with which to supply the 
stock and bond dealers with the money needed to absorb those securi- 


1“ Money Changing,” p. 89. 
2 Cf. 324-325. 


340 DOMESTIC AND FOREIGN EXCHANGE 


ties, finance bills were issued maturing in January, 1913. The demand 
for cover at that time caused exchange rates to rise to such levels that 
large exports of gold became advisable and profitable. During and 
since the World War, loan and finance bills have not exerted the in- 
fluence on either the supply or the demand side of the exchange market 
that they did before that time. With the United States at present 
a creditor nation (and it is difficult to prophesy just how long we will 
be able to retain that position), it is not expected that loan or finance 
bills will in the near future function as actively in the exchange mar- 
kets as they have in the past. 

(i) The money rates at home and abroad also have their effect on 
the demand for exchange. If low money rates rule in the United 
States with high money rates in some foreign center, banks with funds 
to invest for a short period will enter the market as demanders of ex- 
change with which to transfer their accounts abroad so as to take 
advantage of the high foreign money rate. Fluid capital, using those 
words rather loosely as signifying funds in the hands of bankers avail- 
able for investment, is extremely mobile and shifts or is shifted from 
one center to another by cable or otherwise at a moment’s notice for 
the purpose of taking advantage of a slightly higher rate of return. 
Our international bankers are quick to seize an opportunity of getting 
an increase in the yield of their funds.‘ High money rates abroad 
also make it unprofitable for us to renew maturing finance and loan 
bills, and hence tend to stimulate the demand for exchange with which 
to pay such bills when due. Thus it is that we can always expect to 
see low money rates at home and high money rates abroad increasing 
the demand for exchange and tending to raise the exchange rates, 
and vice versa. Low money rates abroad are at times, however, 
linked with low money rates at home. This brings about a slackening 
in the demand for foreign bills, with a resulting tendency to weaken 
the exchange rates on the foreign country. In the first week of June, 
1898, a decline in the discount rate of the Bank of England caused 
bankers to stop purchasing long sterling bills for investment purposes, 

1The Annalist of New York under date of January 15, 1917, stated that: ‘‘The marked 
ease of money rates last week stimulated the investment of banking funds in cotton bills 
and other paper drawn against exports. The process enabled the purchaser to draw in- 
terest at higher rates on an amount of funds in London equivalent to his investment on 
such bills. Before money advanced to the high levels current late in November, it was 
estimated that fully $400,000,000 American funds were being loaned in London in this 


manner, of which more than $100,000,000 was thought to have been drawn back here 
when the money market stiffened.” 


RATES OF FOREIGN EXCHANGE 341 


while easy money rates at home tended to prevent the purchase of 
sterling for future delivery. The result was a heavy market for sterling 
exchange with lower rates prevailing. The student should not over- 
look the fact that the money rates of a country are inseparably con- 
nected with the discount rate of the rediscounting institution or cen- 
tral bank. The discount rate, however, is so important a factor in 
affecting the rates of long bills that we shall devote a separate section 
of this chapter to it. 

(j) There are also those foreign payments which we must make 
to those who have rendered services for us, such as lawyers’ fees, agents’ 
commissions, payments to sales agencies, salaries to foreign employees 
and consular representatives, bankers’ commissions, etc., etc., all 
of which create a demand for exchange. Before the World War we 
paid English discount and acceptance houses large sums of money 
as commissions on various financial transactions. These commissions, 
variously estimated at from $10,000,000 to $150,000,000 have largely 
disappeared as a result of developments during and since the war 
and therefore do not figure as prominently on the demand side as 
formerly. If the present tendency to return to the use of sterling 
letters of credit should continue, it seems safe to predict that in the 
future we shall again be in the market for large sums of exchange with 
which to pay acceptance commissions to English banking houses. 

(k) Exchange is also demanded in connection with arbitrage and 
speculative transactions.” Especially during and since the war has 
speculation been an extremely important factor in the exchange mar- 
ket. First it was the demand for Russian rubles; then for francs and 
lire; later for marks. This speculative demand has been of great 
influence in strengthening the market, and at times has raised the 
speculative exchanges to higher levels than would otherwise have pre- 
vailed. On January 2, 1921, sterling exchange opened at 3.53 @ 3.5414 
and in a month’s time (January 31) it had risen to 3.8344 @ 3.85 3/4. 
One of the strengthening influences was the large outstanding “short” 
interest made up of those dealers who had sold futures, counting on 
covering later through an expected fall in the rate but who were com- 
pelled to purchase at the higher rates for fear of having to cover later 
at even higher prices. 

(1) We have seen that gold exports tend to create a supply of ex- 


1Cf. p. 347. 
2Cf. Chapter XIII. 


342 DOMESTIC AND FOREIGN EXCHANGE 


change and thereby weaken the rates. On the other hand, gold im- 
ports do not of necessity create a demand for exchange, although 
such is usually the case. An importation of gold must be paid for in 
one of two ways: first, by the dealer cabling his correspondent to 
take a certain portion of his (the importer’s) deposit account and to 
use the same in purchasing gold. This cable request, in itself, does not 
create a demand for exchange in the American market, nor does it, as 
a cable, affect the supply; but the procedure does reduce the foreign 
account of the dealer and thereby decreases the supply of exchange. 
Also, when the importing banker later takes steps to build up his 
depleted foreign account, he will have to go into the open market 
and buy exchange, thereby increasing the demand for foreign bills. 
Second, if when the dealer makes his plans to import gold, he finds that 
his foreign account is relatively low, he may be forced to go into the 
market and buy a sufficiently large amount of either cables or sight 
exchange to send abroad to build up his account in order to be able 
to pay for the gold that he wishes to import. This procedure would 
create a demand for exchange and so tend to raise the rates. 

(m) At times, although rather infrequently, the exchange market 
will be disarranged by the payment of an indemnity between nations. 
For example, in 1900 the United States government paid Spain a 
claim for $20,000,000, arising out of the Spanish-American War, and 
for several months our government remained in the market as an 
active demander of exchange, thereby materially increasing exchange 
rates. On May 17, 1921, Germany paid the Reparations Commission 
150,000,000 gold marks, the payment consisting of foreign currencies. 
Germany secured these funds by drawing drafts on credit balances 
which she had accumulated in those countries with which she was 
trading. The Reparations Commission found itself possessed of a 
miscellaneous volume of drachmas, lei, francs, dollars, guilders, and 
every conceivable unit of currency in commercial use in the world, and 
requested Germany to convert these foreign funds into dollars. Ger- 
many did so by May 31, with the result that her demand for dollars 
strengthened the dollar quotation and weakened practically every 
European rate, sterling, for example, falling from 4.00 on May 19 to 
3.86 on May 31. The Reparations Commission finally authorized 
Germany to pay in any foreign credits which she might possess in 
order to prevent the disturbing effects of similar demands for dollar 
credits in the future. 


RATES OF FOREIGN EXCHANGE 343 


Before bringing to a close the discussion of the supply of and the 
demand for exchange, several other matters should be briefly referred 
to. For example, the reader must always keep in mind that when 
we state that increasing the supply of exchange tends to weaken the 
rate, or that decreasing the supply tends to stiffen it, we mean that 
such statements hold true provided the demand factor remains con- 
stant; and likewise, when we say that increasing the demand stiffens 
the rate or that decreasing the demand weakens it, we mean that the 
supply factor remains constant. It is not unusual, however, to find 
that an increased supply or a decreased demand does not weaken the 
rate, or that a decreased supply or an increased demand does not 
strengthen it, the reason being that the other factor has not remained 
constant and consequently has affected the condition of the market 
in a manner that was not anticipated. Also, one must not overlook 
the fact that there may be any number of bills drawn on creditors in 
a foreign country that are not sold to exchange dealers in the country 
of origin, but instead are sent abroad for collection. Such bills do not 
affect the supply side of the market until actually collected and the 
funds so obtained have been added to the foreign account of the ex- 
porter’s collecting agency. The funds may then be returned to the 
country of origin in one of two ways: (a) the collecting agency may 
draw drafts on the foreign account, sell them in open market, and thus 
receive funds with which to pay the exporter; or (4) the collecting 
agency may advise its foreign correspondent to remit the account by 
means of sight drafts or cables. The first method creates a supply 
of exchange on the foreign country; the second method creates a 
demand in the foreign country for exchange on the exporter’s country. 
Both affect the exchange rate in the exporter’s country in the same 
manner, i. e., they tend to lower the rate. To illustrate: a demand 
in France for dollar exchange raises the rate for dollars, or what 
amounts to the same thing, it lowers the value of the franc, because 
it then takes more francs to buy a dollar. <A supply of franc ex- 
change in the United States lowers the value of the franc, or increases 
the value of the dollar because the latter then buys more francs. 
In this way, bills that are collected abroad may ultimately result in 
(a) a demand in the foreign country for exchange on the country of 
origin, or (b) in the creation of a supply of exchange in the country 
of origin on the foreign country, both of which in the end, as we have 
seen, have the same effect on the market. 


344 DOMESTIC AND FOREIGN EXCHANGE 


A draft drawn on a party in a foreign country, say France, and dis- 
posed of in the country of origin, say the United States, may add to 
the supply of franc exchange in the United States, or it may create 
a demand for dollar exchange in France, but it cannot affect the supply 
side in the United States and the demand side in France aé the same 
time. When it is offered for sale to an exchange dealer in the United 
States, it is clearly a part of our supply of franc exchange. But it 
cannot at the moment of sale affect the demand for dollar exchange 
in France. When the bill reaches France and is finally paid, say seven 
or ninety days later, the French correspondent may then possibly 
be requested to purchase dollar exchange and remit it to the American 
dealer. Such a proceeding is rather unlikely to occur, but still it is 
practically possible. Thus the existence of a supply of franc exchange 
in the United States may ultimately lead to a demand for dollar ex- 
change in France, but where only two countries are concerned it is not 
possible for the franc draft to figure simultaneously as a supply factor 
here and as a demand factor abroad. 

The situation becomes slightly different, however, when we discuss 
relations that may arise between merchants and bankers in three 
countries. Say, for example, that a German bank issues a commercial 
letter of credit to a German importer, under the terms of which the 
drafts are to be drawn on an English bank, and that the letter of 
credit is forwarded to an American exporting firm. The draft that 
the American firm draws on the English bank may be considered as 
increasing the supply of sterling exchange in the United States and 
also at the same time as resulting in an increased demand for sterling 
exchange in Germany. In this case the draft drawn on England by 
the American firm will be sold in the New York market, thereby adding 
to the supply of sterling exchange in that market. The German bank 
that issued the letter of credit upon the London correspondent will 
have to reimburse the latter, i. e., cover the sterling draft drawn by 
the American exporter, thus increasing the demand in Germany for 
sterling exchange. 

Trade relations between three countries may in various ways affect 
the demand for, or the supply of, exchange of those countries in a 
most interesting manner. Say that American importers owe English 
exporters; that German importers owe American exporters; and that 


1 To get the funds back to the United States, the customary practice is for the American 
banker to sell franc drafts against his account. 


% 


RATES OF FOREIGN EXCHANGE 345 


English importers owe German exporters. The usual method of 
handling such a situation would be for the United States firms to 
draw on the German firms so as to get the money which was due them; 
the German companies would likewise draw on the English importers; 
and the United States importers would remit to the English exporters. 
The American bankers who purchase the drafts drawn against the 
German firms may and frequently do send such drafts to their English 
correspondents for collection, the amounts collected to be credited 
to their English accounts. When these drafts reach England they 
are forwarded to German correspondents who in their turn collect 
the amounts due and then purchase sterling exchange with which to 
make remittance to the English bankers. Thus it is that the existence 
in the United States of mark drafts leads to the creation of a demand 
in Germany for sterling drafts. The German banks that sold the 
sterling exchange for remittance in the above connection undoubtedly 
had built up their accounts in England by purchasing the drafts that 
the German exporters had drawn on the English importers. 

To cite another possible situation, say that England buys cotton 
from the United States, that Germany buys cloth from England, and 
that the United States purchases scientific instruments from Germany. 
We would draw drafts on England in order to receive money owing 
us by the English importers. These drafts would be purchased by the 
American bankers and might be sent to Germany for collection from 
England, the idea of the American bankers being to build up their 
accounts in Germany. The German bankers would send these drafts 
to England and ask that the funds be deposited to their accounts. 
They would thus have a supply of sterling exchange available with 
which to satisfy the needs of the German importers who require 
it for remittance to England to pay for the cloth. A supply of sterling 
exchange in the United States has thus led to the creation of a sup- 
ply of sterling exchange in Germany. Or it might be that the 
American importers would send sterling commercial letters of credit 
to the German exporters, who would draw drafts on English banks for: 
goods shipped to the United States. And in this way a demand for 
sterling exchange in the United States would lead to the creation of a 
supply of sterling exchange in Germany. 

It is not unusual for a debtor in one country to pay a creditor in a 
second by means of exchange drawn on a third. An importer in New 
York may pay an exporter in Paris by sending him a draft on London. 


346 DOMESTIC AND FOREIGN EXCHANGE 


The Parisian will be compelled to sell his sterling draft in Paris in 
order to obtain his money. This adds to the supply of sterling ex- 
change in Paris. The Parisian banker who purchases the draft will 
forward it to London for collection, and have the proceeds credited 
to his London account. Thus the existence of a demand for sterling 
exchange in the New York market has created a supply of sterling 
exchange in the Paris market. Or if the Parisian banker asks that the 
funds, when collected in London, be remitted to him, franc exchange 
will be purchased in London in order that the funds may be returned 
to Paris. The existence of a demand for sterling exchange in New 
York has therefore led to the creation of a demand for franc exchange 
in London. While to the uninitiated this might seem to be a round- 
about way of making payments in international transactions, it is not 
sO uncommon as one might suppose. Sterling drafts have been uni- 
versally used in such connections. 

In 1912, Germany exported about £13,000,000 worth of goods to 
Argentina, but imported far less than that amount from her. The 
difference was undoubtedly paid for by means of sterling remittances 
sent to the German exporters by the Argentine debtors, drawn against 
credits which had been built up in England as the result of large 
English purchases of foodstuffs from the exporters of Argentina. 
Especially has it been customary among South American countries 
for payments to be made to each other or to foreign nations by means 
of 90 day drafts drawn on London. 

Four-cornered transactions similar to the above triangular operation 
were frequently engaged in during the World War. The Aznalist 
of May 7, 1917, in describing such a four-cornered operation, stated 
that: 


“Russia owes Japan for war munitions, ships, steel, etc., but is forced 
by the exigencies of war to borrow in London to pay the bill. London in 
turn is a heavy borrower in New York, and so theoretically the burden 
is passed along to the New York market. Japan, then, in order to get 
her money, draws on New York, and it happens that at the same time she 
has a heavy trade balance here, resultant from extraordinary exports to 
this country. The addition of this debt to the debt of Russia, which has 
been shifted to the American market, acts to depress the value of the dollar 
in Tokio and makes more easy the outflow of gold. Last week shipments 
were made from San Francisco to a total in excess of $4,000,000, and the 
continuance of the flow is expected for some time.” 


RATES OF FOREIGN EXCHANGE 347 


Ill. The Discount Rate. The discount rate prevailing in foreign 
markets is an important matter that is kept in mind by every ex- 
change dealer in purchasing acceptance bills. If a New York dealer 
purchases a long bill and sends it to London when the discount rate 
is high, he will receive less when it is discounted than if the discount 
rate had been lower. It is for this reason that the New York dealer 
pays less for long bills when the discount rate is high than when it is 
low. The discount rate applies only to long bills. Sight bills are never 
discounted because they are payable on demand. It is not unusual 
to have demand drafts on London sell for 4.86, and to find that the 
American exporter can obtain but 4.81 or 4.82 for his 90 day bills 
because of the high discount rate in London.! Conversely, if the dis- 
count rate abroad is low, the exchange dealer will be able to secure a 
greater return on bills discounted abroad and consequently will be 
willing to pay a higher exchange rate for them. Thus, in 1908, the 
discount rate of the Bank of England was lowered from 7 per cent on 
January 2, to 6 per cent on January 3; to 5 per cent on January 17; 
to 4 per cent on January 24; to 3% per cent on March 6; to 3 per cent 
on March 20; and to 244 per cent on May 29. The rates for 60 day 
acceptance bills on those dates were respectively: 4.7950 @ 4.7975; 
4.80 @ 4.8025; 4.8210 @ 4.8220; 4.8340 @ 4.8350; 4.830 @ 4.8325; 
4.8315 @ 4.8325; 4.8520 @ 4.8530; a consistent though not a pro- 
portionate increase being shown as the discount rate was lowered. 

The influence of the discount rate in narrowing the spread between 
the quotation for long bills and sight exchange will be discussed in the 
following section, while its connection with the flow of gold will be 
considered in the next chapter. 

IV. Usance of Bills. The length of time for which the bill is to 
run before payment is made, i. e., its length of life, is a factor that also 
influences the rates charged or paid on any particular day for the 
different kinds of exchange. The sight or demand rate, as Whitaker 
so well says, “is forged out in the open market between the hammer 
and anvil of bid and offer,” * (supply and demand), but the rates for 
cables and long bills are always calculated on the basis of the sight 


10On January 3, 1908, the Bank of England discount rate stood at 6 per cent; the open 
market rate at 5 per cent. The rates of sterling exchange on that day were: 60 day bills, 
4.7905 @ 480; sight bills, 4.8470 @ 4.8475; cables, 4.8575 @ 4.86. On January 2, 1913, the 
Bank of England discount rate stood at 5 per cent, the open market rate between 4 per 
cent and 5 per cent. The rates of sterling exchange on that day were: 60 day bills, 
4.8155 @ 4.8165; sight bills, 4.8570 @ 4.8580; cables, 4.8630 @ 4.8640. 

2 Op. cit., p. 274. 


348 DOMESTIC AND FOREIGN EXCHANGE 


rate and are not in themselves subject to any great extent to the in- 
fluences that focus upon the sight rate. There has been some con- 
troversy among exchange dealers, as well as among those who have 
written on the subject, as to whether or not the sight rate or the cable 
rate should be taken as the basis for the calculation of the other ex- 
change rates. The American Express Company in a late number 
of its Foreign Trade Bulletin calls attention to the fact that “ It is 
interesting to note that the cable rate of exchange is the real rate indi- 
cating what the United States dollar is actually worth day by day, 
in terms of each foreign currency.’”? Whitaker, on the other hand, 
maintains that: 


ce 
. 


. it must be confessed the thought that the cable rate is the ‘real 
exchange rate,’ unadulterated by discount or interest, so to speak, is an 
attractive idea to both the theorist and the banker. But be this as it may, 
the various long rates (and also the rates for merchants’ sight bills, which 
are sometimes drawn) are tied to the rate for bankers’ sight drafts in a 
way in which they cannot be connected with the cable rate. The spread 
between a long rate and the sight rate can be calculated at the time of the 
purchase of the long exchange, from factors which are then all foreknown. 
Neither speculation nor investment enters in. But the purchase of any 
kind of bill cannot be counterbalanced by a sale of cables without both a 
speculation and an investment of funds being involved. And so a banker 
cannot base his buying rate for long bills upon the cable rate without putting 
into the spread one speculative element, or one factor that is guesswork. 
The point remains even if under very quiet conditions the degree of specu- 
lation may be slight. . 

“The rates for exchange which takes the abit of written instruments 
that have to be transmitted by mail to the place where they are payable, 
happen then to be more intimately connected with each other than with 
the rate for telegraphic transfers. The sight rate is basic among this larger 
group. The sight rate and the cable rate are related, but the spread be- 
tween them contains an ineradicable speculative element. Whether the 
cable rate is in some theore tical sense the basic one as between these two, 
is a question that it is practic ally idle to discuss. In point of fact the sight 
rate is not determ ined by a calculation from the cable rate... . Under 
ordinary condition s at least, the market would no more think of calculating 
sight rates from cable rates than the tail would think of wagging the dog.” ! 


In actual practice the sight rate is always the starting point in all 
exchange calculations whether they concern the purchase of short or 


1Op. cit. pp. 273-4. 


RATES OF FOREIGN EXCHANGE 349 


long bills or the exchange rate at which gold may be profitably im- 
ported or exported. 

A bank at any particular moment may be selling cables on London 
at 4.8715, sight drafts at 4.8675, 60 day drafts at 4.8305, and go day 
drafts at 4.815. In quoting the cable rate, the cost of the message 
itself is not included. Cables command a higher rate because they 
call for immediate payment. It takes but a few hours from the time 
a cable is sent until the sum it represents is deducted from the foreign 
account of the selling bank. From the standpoint of the dealer the 
sale of a cable allows no opportunity to earn interest on the trans- 
action. If he sells a sight draft he has the use at home of the money 
which he receives for it and for the length of time that it takes the 
draft to reach London and be paid. In the meantime he also receives 
interest on an equal amount of money in his foreign account. Because 
he gains no interest on the sale of cables, he charges a higher rate there- 
for than for other kinds of exchange. From the standpoint of the 
purchaser it can be said that the cable enables him to wait until the 
last moment before making payment abroad, and so makes it possible 
for him to retain the use of his money for that length of time. The 
purchaser is willing therefore to pay more for a cable than for other 
kinds of exchange. If money rates are high, the purchaser in buying a 
sight draft will lose more interest than when money rates are low, and 
vice versa. If he buys a cable when local money rates are high, he 
gains more interest on his money at home and is therefore willing to 
pay a higher rate for a cable than when money rates are low. Money 
rates thus exert an influence upon the spread or difference between 
the rates paid or charged for demand bills on the one hand and those 
paid or charged for cables and long bills on the other. During 1908-09 
a period of cheap money in the United States, the rates for sterling 
cables and demand drafts were often less than one-half cent apart. 

The rates charged by a bank for 60 and go day bills, as well as the 
rates at which a bank will purchase such bills, are less than the rates 
charged or paid for sight drafts because the bank gains interest on the 
funds in the case of long bills sold, and loses it in the case of long bills 
purchased. If a bank sells a 60 day draft to a customer, the bank 
has the use of the money received therefor, as well as the interest on an 
equal sum of money in its foreign account, during the days that 
intervene before the draft is cashed and its face value deducted from 
the foreign account of the issuing bank. The purchaser of a long bill 


350 DOMESTIC AND FOREIGN EXCHANGE 


invests his money a certain number of days ahead of time with the 
result that he loses interest on the amount involved. He will there- 
fore not pay so much for a long bill as he will for a sight draft. Like- 
wise when a bank buys a 60 day draft from an exporter, if it isa D/A 
bill, the bank will not be able to obtain the face value of the draft un- 
less it holds the draft until maturity, in which event it will lose interest 
on the funds invested for the time involved. If the bank orders its 
foreign correspondent to discount the D/A bill immediately upon 
acceptance—and the greater part of such bills are immediately dis- 
counted—the bank receives the face value of the draft minus the dis- 
count. The bank will in the first case lose interest for the time in- 
volved, while in the second case it will lose the discount charged. A 
bank cannot afford, therefore, to pay as much for a long bill as it can 
for a sight draft. If the long bill that the bank purchases from the 
exporter is a D/P bill, it cannot be discounted in the London market, 
and the bank may have to wait until the maturity date before it gets 
its money out of the transaction. If the acceptor pays the bill before 
maturity the bank is compelled, according to the custom of the trade, 
to give him a rebate.! The rebate rate, as a rule about 1 per cent less 
than the discount rate, causes less pounds sterling to be taken off the 
face value of the bill than if the bill is discounted. Because of this 
fact, certain types of D/P bills that it is highly probable will be paid 
as soon as presented for acceptance command higher rates of exchange 
than do some kinds of D/A bills. As Escher says, “. . . bills 
for payment drawn against perishable goods which must be paid 
under rebate as soon as the goods arrive, command a better rate of 
exchange than even the best bills where documents are handed over 
to the consignee on acceptance.” ? Sixty day D/P bills against grain 
shipments are usually, though not always, purchased by exchange 
dealers at higher rates than even the very best D/A cotton bills drawn 
on English bankers.® 

1 Chap. taAc 

2 Jefferson and Escher, of. cit., p. 315. 

3On May 6, 1808, rates for grain payment bills on London were 4.8014 @ 4.8034, while 
rates on sterling cotton acceptance bills were 4.8014 @ 4.80%, and on cotton payment 
bills, 4.7914 @ 4.7934. Again, to cite another instance, on September 5, 1913, the rates 
for commercial acceptance bills on London banks, including cotton acceptance bills, were 
4.801% @ 4.82%, while grain payment bills were at 4.82 @ 4.821%, and cotton payment 
bills at 4.8134 @ 4.82. As stated above, grain payment bills do not always command higher 
rates than cotton acceptance bills. Thus, to cite only one instance out of many: on June 3, 


1898, rates for sterling cotton acceptance bills stood at 4.8334 @ 4.84, while rates for sterling 
grain payment bills stood at 4.83% @ 4.83 1/2. 


RATES OF FOREIGN EXCHANGE 351 


When a bank purchases a trade acceptance, another element ap- 
pears that is frequently overlooked by the student of the exchanges, 
and that is that the risk of non-payment increases with the usance 
of the draft. A firm may be of excellent standing at the time that 
it draws or accepts a draft, but before the bill matures the firm 
may have become bankrupt. Again, in two or three months’ 
time the money rates in the market may fluctuate so adversely 
as to wipe out the holder’s profit. The time element, therefore, 
must always be considered by the banker in buying acceptance 
paper. 

Cables are always higher and long bills are always lower than sight 
bills. Their rates will ordinarily roughly parallel the sight rate, the 
long rates being at a greater distance below the sight rate than the 
cable rates are above it. This again is because the element of time 
is involved, the time in the case of long bills being greater than in the 
case of cables. Referring to Charts II! and III,? and to Tables XI 3 
and XII * it will be noted that sterling cable rates are normally from 
25 to 50 points higher than sight rates. Naturally, of course, there 
are exceptions to this general statement, as, for example, during the 
panic of 1907-08 when at one time cables were 375 points higher than 
sight bills ° although a few months later they were only 10 points 
higher. Again during the first days of August, 1914, a most surprising 
spread occurred when sterling cables were quoted at 7.00 with sterling 
sight at 6.00, a spread of 10,000 points.’ Sterling bankers’ 60 day 
bills will usually range from 350 to 425 points below sight bills, 
while 60 day D/A commercial bills on banks will range from 500 to 
650 points below sight bills, a spread of about 150 to 225 points 
greater than in the case of bankers’ bills. For example, during the 
period of 1907-08, the spread for sterling bankers’ 60 day bills ranged 

1P, 362. 

2P. 363. 

3P. 360. 

4P. 361. 

5On November 7, 1907, the highest sterling sight rate was 4.865 and the highest cable 
rate, 4.90, a spread of 334¢ or 375 points. 

6On August 17, 1908, the highest sterling quotation was 4.865 and the highest cable 
quotation was 4.866, a spread of 1/ 10¢ or 10 points. 

7 The average spread between the lowest quoted cable rates for sterling and the lowest 
quoted sterling sight rates, taking only the closing weekly quotacions for the period, October, 


1907-September, 1908, was 23 points; and for 1913, 50 points. Cf. Tables XI and XII, 
pp. 360-361. 


352 DOMESTIC AND FOREIGN EXCHANGE 


from 120 to 775 points, and for 60 day D/A commercial bills on banks 
from 140 to 1025 points.? 

A question that inevitably arises in connection with any discussion 
as to the effect of the length of the life of the bill upon the rate is, 
what determines the spread, i. e., the variation between the demand 
rate on the one hand and the rates for cables, short bills and long bills 
on the other. In considering this question, the student must not over- 
look the fact that the exchange dealer acts in a dual capacity, i. e., 
he is both buyer and seller. As a buyer he has to consider the value 
of his money as it stands, part of it abroad in foreign accounts and 
part of it at home in his own vaults or loaned out in the home market. 
Are there plenty of satisfactory investment opportunities at home; 
are his funds that are invested locally earning as much as they would 
if invested in a bill of exchange to be discounted later at the rate exist- 
ing in the foreign money market; can he secure a larger return on his 
money by investing it in such bills of exchange to be discounted abroad 
or paid under rebate or held until maturity, or, on the other hand, 
can he make a greater return by keeping his funds loaned out on call 
in the home market? As a seller of exchange, he has to keep in mind 
whether his money abroad is earning a higher return than it would 
if he should bring it home through the sale of exchange and loan it 
on call in New York City. If he sells cables he will lose part of his 
account in London immediately and at the same time add to his funds 
in New York. If he sells sight exchange or long bills he will have the 
use of his funds in London until the drafts are paid and at the same 
time the use at home of a sum of money equal in amount to the face 
value of those drafts. Asa buyer of exchange he loses the use of money 
in New York and is out of the funds covering the transaction until 
he has realized on the exchange in the foreign center. Thus, no matter 
in what capacity he acts, and no matter what sort of exchange he buys 
or sells, he will be governed primarily, though not necessarily solely, 
by the money rates prevailing both at home and in foreign centers. 
May we not therefore lay down the general rule that money rates 
both at home and in foreign centers are the important, but not the sole, 


1 From October, 1907, to September, 1908, the average spread between the lowest quoted 
sight rates and the lowest quoted bankers’ 60 day bills, using only the closing weekly quota- 
tions, was 310 points, and for the year 1913, 393 points. From October, 1907, to September, 
1908, the average spread between the lowest sight rates and the lowest quoted 60 day 
D/A commercial bills, again using only the closing weekly quotations, was 356 points, and 
for the year 1913, 591 points. 


RATES OF FOREIGN EXCHANGE 353 


factor that determines the spread? There are so many other influences 
at work affecting exchange rates—just as in the open market there are 
so many influences affecting the price of any commodity—that the 
most that can be said of any “law” or “principle” in this connection 
is that, “In general, it may be true,” and that “Under all circum- 
stances it must be interpreted and applied in a most general and 
liberal manner.” In fact, no law or definite rule can be laid down. 
At best one can offer only an “explanation.” In the field of commodity 
prices, we have no universally accepted /aw that explains where indi- 
vidual prices are fixed and why. All suggestions are mere theories or 
explanations. All that can be said is that out in the market the seller 
tries to fix his prices at those levels that will net him a profit, large or 
small as the circumstances permit. The same general statement 
applies to the question of the spread between exchange rates. A 
grocery storekeeper does not know whether he has made a profit until 
he strikes a balance at the end of his business year. He cannot know 
whether or not each article that he is selling is bound to yield a profit 
in the end. But he tries to watch his expenses and his prices in the 
hope that his business will be profitable. The same is true of the ex- 
change dealer. He has funds to invest. He tries to keep them at work 
and to the best advantage. He hopes at the end of, say, every six 
months, to strike a balance sheet that will show a profit, and it is his 
funds, the money rates abroad, and the money rates at home that 
are the elements with which he works and from which he hopes to 
derive his profits. 

In considering the spread between sight exchange and long bills 
many writers concern themselves solely with the influence of the 
foreign (domicile country) rate of discount. Others, quite properly, 
also include the discount rate of the home (drawing) country. Practi- 
cally all writers declare or imply that the discount rates abroad and 
at home are the only factors that enter into the calculation of the 
spread in the market and that as discount rates rise one per cent the 
long bill rate should fall one per cent., and vice versa; in other words, 
that there is a rather direct or proportionate relation existing between 
the rise and fall in the discount rate, especially the foreign discount 
rate, and the rates ruling for long bills. Whitaker, more careful than 
the rest, remarks that, “In an ordinary case, perhaps 9/10 of the spread 
will be due to discount.”’! He then raises the question as to “which 


OS. Cti 5 Dv 500: 


354 DOMESTIC AND FOREIGN EXCHANGE 


discount rate is it that governs, that in the drawing city (e. g., New 
York) or that in the domicile city (e. g., London).’’! Let us proceed 
to take up the various points involved, first theoretically and then 
practically to see whether or not we can discover a “theory” or “law” 
that is wholly or partially applicable to actual transactions. 
Theoretically an exchange dealer having funds at home and abroad 
will always shift his funds back and forth in order to get the greatest 
possible returns. If money rates are higher at home than abroad he 
will bring his funds home and will refuse to invest money in foreign 
bills. Bringing his funds home involves the sale of exchange, primarily 
cables and sight, with a resultant increase in the supply of exchange 
on the market. His refusal to invest in foreign bills means a decrease 
in the demand therefor. An increased supply and a decreased demand 
normally cause a lowering of exchange rates. Sight rates cannot fall 
lower than the gold import point and remain below it for any length 
of time because of the corrective influence of the gold flow.” The 
rate for long bills is not directly affected by the gold flow except as it 
(the long rate) is tied to the sight rate. If bankers can purchase long 
bills at rates low enough so that they are able to obtain therefrom a re- 
turn equal to the rate being paid on money in the home market, they 
will invest. In other words, they will then purchase the exporter’s bills 
at the higher home discount rate, which will cause long bills to sell for 
a low rate and thus increase the spread between the long rate and 
the sight rate. The long bills will then be sent abroad and discounted 
at the lower discount rate in the domicile (foreign) country, thus 
netting the exchange dealer a nice profit. However, competition 
develops among the local exchange dealers who actively bid for the 
exporters’ bills in order to make the larger than customary profit, 
and as a consequence the rate for long bills rises, and the spread 
between it and the sight rate decreases. If competition is strong 
enough, the long bill exchange rate may be raised so high that the 
home bankers will receive only their discount on the face of the bill 
calculated at the lower foreign discount rate. ‘Thus in this case the 
maximum spread would be fixed by the lower discount rate abroad. 
The day to day spread would fluctuate between these two extremes. 
It must always be remembered that the exchange dealer uses the 
present or existing sight rate as the basis for his estimate of the value 


1Op. cit., Pp. 590. 
2 Cf. pp. 412-413. 


RATES OF FOREIGN EXCHANGE 355 


of a long bill of exchange. The other two factors in his calcula- 
tions are the discount rates at home and abroad existing, again, on 
the day of his purchase, although as has been noted earlier,! 
“forward discount” rates sometimes enter into exchange calcula- 
tions. 

To reverse the process, suppose the foreign discount rate is higher 
than the home discount rate. This signifies that bankers’ funds will be 
more valuable abroad than at home. The banker will hesitate to sell 
sight or cable exchange because he wishes to keep his funds profitably 
employed abroad. He will likewise be in the market as a buyer of 
sight or cable exchange so as to send his funds abroad in order to ob- 
tain the larger return. The decreased supply and the increased demand 
will tend to raise the rates for sight bills and for cables. Sight rates 
will rise, but they cannot exceed the gold export point for any length 
of time because of the corrective influence of gold exportations.”__ But 
what of the rate for long bills? Long bills if purchased and sent abroad 
for discounting will have to be discounted at the higher discount rate, 
i, e., more will have to be taken off their face value,—they will not be so 
valuable as they would be with a lower foreign discount rate. Hence 
the bankers will pay proportionately less for them. This results in a 
low price for long bills and a greater spread between the long rate 
and the sight rate. Bankers, however, then see the advisability of 
investing their funds in the low priced long bills to be held until 
maturity, because by so doing they will receive the higher discount 
thereon (calculated on the basis of the higher foreign discount rate); 
and with the low money rates in the local market, such investments 
may prove to be more profitable than any other form of paper. Com- 
petition for such bills again develops, but this time for investment, 
not for discount as was the case in the former example. This causes 
the rate for long bills to rise and decreases the spread between the 
long and the sight rate. But the long rate cannot rise any higher than 
will be permitted by the existing lower discount rate in the home 
country. In other words, bankers will not pay a higher exchange rate 
for long bills that will yield them a smaller return (calculated on the 
low home discount rates) than they can get by investing their funds 
in other kinds of paper. Hence, again, the higher discount rate, this 
time the foreign discount rate, fixes the maximum spread; and the 
lower discount rate, this time the home discount rate, fixes the mini- 

1Cf. pp. 314-315. 2 Cf. pp. 412-413. 


356 DOMESTIC AND FOREIGN EXCHANGE 


mum spread. The spread from day to day will vary between these two 
extremes. But in both this and in the former example, the tendency 
will be for the lower discount rate to govern, i. e., to exert a strong in- 
fluence in decreasing the spread between the sight rate and the long 
rate through the competition of the exchange dealers for the more 
profitable form of investment. The lower discount rate will not com- 
pletely govern because there is always a possibility of a fall in the 
sight rate which might wipe out profits if the long bills have been 
purchased on the basis of the lower discount rate. When sight rates 
are high, which is apt to be the case when foreign discount rates are 
high, there is always a possibility of their declining somewhat. High 
discount rates increase the demand for exchange, raise the sight rate, 
and attract funds. Ample funds being thus obtained, the discount 
rate falls and demand for exchange eases off, and the sight rate falls. 
The dealer always has to take the future trend of exchange rates into 
consideration in purchasing long bills, the returns from which are to 
be used as the basis for future sales of cables and sight drafts. So the 
dealer will not be willing to approach too close to the margin, and 
therefore will not calculate his purchase price for long bills on the basis 
of the lower discount rate, but always somewhat above it.’ 


1 Whitaker, who presents an excellent discussion of this entire matter of the spread, 
takes a slightly different point of view. He states that, ‘‘When the discount rate in the 
domicile city is the lower of the two, it alone governs that part of the spread due to discount. 
When the discount rate in the drawing city is the lower, it may affect, though it will not fully 
govern the spread. Stating this in a slightly different form, the spread can never be greater 
than the figure proportionate to the discount rate in the domicile city, but it may be less 
than this when the discount rate in the drawing city is lower, though it will not become 
much less.” The reason assigned for the last statement is that with a high money rate 
abroad and a low money rate here, the home bankers will bid actively for foreign long bills, 
which they will hold as an investment. This active bidding raises the exchange rate, which 
results in a decreased spread, but the spread will not be decreased sufficiently to correspond 
to the lower money rate existing in the home market. Whitaker, who follows the rule ad- 
vanced by Prof. N. G. Pierson (‘‘ Principles of Economics,” London, 1920, pp. 527-9), 
would undoubtedly accept Pierson’s statement that when the rate is lower in the foreign 
country (e. g., London) it governs that part of the spread due to discount because, as Pier- 
son says, ‘“‘As the London rate of discount is known everywhere, holders of long-term bills 
on London will not accept a lower price for them than that for short-term bills, less interest, 
at the rate current in London.” Theoretically this is correct, for in the field of theory we 
go on the basis of all buyers and sellers being supplied with all the available and necessary 
information regarding a situation, and being free to act according to their desires in the 
matter. Practically, this is not true, because exporters who have bills to sell do not know 
the market and are usually not in touch with its trend, possibilities, etc. They have no 
correspondents in London to whom they can send their bills if they are not satisfied with 
the exchange rate offered by the New York dealer. Of course, if over a long period of time 
they become thoroughly dissatisfied with the prices offered for their bills, they may pos- 
sibly make connections with London correspondents, send their bills abroad, have them 
discounted, and the proceeds credited to their account in a foreign bank. But such a state 


RATES OF FOREIGN EXCHANGE 357 


Looking at the matter from a slightly different angle, one might 
think that the difference or the margin between the discount rate at 
home and that existing abroad might give a clue to the variation in, 
or serve as a sort of gauge in estimating, the spread between sight 
and long bills. Clare ' in following out this idea approaches the prob- 
lem from a slightly different point of view, suggesting that the vari- 
ation of the sight rate from the long rate is due to the influence of the 
discount margin. He claims that if, because of a better discount rate 
existing in the domicile (foreign) country, the dealer bids higher for 
long bills on that country so as to invest his funds therein, he will in 
turn be compelled to sell sight exchange on the domicile country at a 
higher rate. Consequently, there is a close but not an “arithmetical 
relationship between an increase in the discount margin and a rise 
in the sight-exchange.”’? Clare seemingly attempts to tie the sight 
rate to the long rate, rather than the long rate to the sight rate, through 
the variations in the discount margin. He presents some interesting 
charts with explanations that appear to justify his general conclusions 
for the years which he examines. We shall shortly * apply his theory 
to sterling rates in the United States during a normal and an abnormal 
year, and shall then see whether or not his explanation is of any ser- 
vice in helping us to solve the problem we are now discussing. 

We have omitted thus far all mention of the varying rate of profits 
that a banker expects to get through the purchase of long bills. The 
profit usually runs from 1/8 cent to 2 cents. In our theoretical dis- 
cussion we have been dealing with all bankers as a class, all of them 
calculating prospective profits on the same basis, and all being un- 
moved by any other circumstance than the cold single purpose of buy- 
ing long bills for the largest possible profit. In actual practice, one 
banker might be content with a profit of 1/8 cent, another with nothing 
less than one cent, etc. —The minimum and maximum spreads in each 
case would necessarily be different. Or if no profit were to be made by 
any banker, the minimum and maximum spreads would not be the 
same as though we had included a varying profit, although they would 
be proportionately just as far apart. 


of affairs would not normally occur. It is because of this fact that the lower foreign dis- 
count rate does not govern so completely as Pierson and Whitaker seem to suggest is the 
case. 

1“The A. B. C. of Exchanges,’’ Chapters 14-16. 

2QOp. cit., p. 92. 

8 Cf. pp. 350-364. 


358 DOMESTIC AND FOREIGN EXCHANGE 


When we come to a consideration of the spread between cable and 
sight bills, we find that theoretically it is supposed to be gauged or 
determined, not by the open market discount rate prevailing in the 
foreign or home markets, but by the rate of interest allowed dealers 
on their foreign accounts, 1. e., the deposit allowance rate. ‘This is 
closely tied to the official bank discount rate, being usually one per 
cent lower. As we have seen, when an American banker sells a sterling 
cable he loses the amount of the cable, within a few hours, from his 
London account. Had he sold a sight draft he would have obtained 
the interest on the foreign account for at least six days longer (not to 
mention the use of an equal sum of money at home during the interim). 
Consequently, when he sells a cable he is supposed to charge not less 
than the rate for sight bills plus the interest lost on his foreign balance. 
If the sterling sight rate is 4.87, and the London deposit allowance 
rate is 3 per cent, he would presumably not be willing to sell a cable 
for less than 4.87 plus the loss of six days’ interest at 3 per cent, or 
4.8724 (4.87 + [6/360 X 3 per cent X 4.87]). The closest quotation 
to 4.8724 would be 4.8725. This rate would not include a profit, yet it 
involves a spread of 25 points. Ifa profit were to be obtained the rate 
would have to be made correspondingly higher and the spread there- 
fore greater. 

We saw that too great a spread between sight and long bills proved 
to be its own corrective through the heavy purchase of long bills by 
bankers, thus raising the rate for the latter and thereby decreasing 
the spread. Too small a spread would likewise prove to be its own 
corrective because if the spread should perchance become so slight 
that the bankers would not be able to make the lower discount rate 
on their investment of funds, they would refuse to purchase, thus 
reducing the demand for exchange and consequently increasing the 
spread. Customers who would purchase bankers’ 60 day bills for 
remittance abroad would find it financially worth their while to pur- . 
chase sight drafts rather than pay the high rate for 60 day bills. This 
would increase the demand for sight bills, would tend to raise the 
sight rate, and so increase the spread. Likewise in the case of cables 
and sight bills too small a spread is normally its own corrective. If 
the two rates get too close together, bankers are able to sell demand 
bills at high rates as compared to cable rates. This will cause them 
to go so far as to sell short, hoping to cover at about the same rate by 
means of cables. ‘They will therefore receive the money from their 


RATES OF FOREIGN EXCHANGE 359 


sale of demand bills and will have the use of it for at least six days 
before having to purchase cables to cover. Selling demand bills short 
increases the supply of sight exchange and lowers the rate. Covering: 
with cables means an increased demand for cables and a higher rate 
therefor. The increased supply of sight bills and the greater demand 
for cables tend to push the rates farther apart and to bring the spread 
back more nearly to normal. If the spread between cables and sight 
bills becomes too great, bankers will appreciate the extra profits that 
can be made from the sale of cables and will take steps immediately 
to create or obtain a larger checking account abroad so as to use it 
for that purpose. A demand will therefore arise for any kind of ex- 
change that can be sent abroad and realized on. The exchange rates 
for long bills and for sight bills will rise and the spread will decrease. 
On the other hand, too high a rate for cables as contrasted with sight 
bills, i. e., too great a spread, will lead to a decrease in the demand 
for cables. Customers will prefer to satisfy their needs where possible 
by means of sight bills. This decreased demand for cables will have a 
weakening effect on the cable rate and will tend to reduce the spread. 
For the time being the demand may be so unusually heavy that the 
rates may rise to unheard of levels, as was true during the strenuous 
days of August, 1914, but in the long run the supply is increased or 
the demand is decreased, and the spread again reverts to normal. 

In order to test the theory of spreads outlined above, two typical 
years have been taken, 1913 for a normal period and the period, Octo- 
ber, 1907-September, 1908, for an abnormal period characterized by 
panicky conditions and not by a world war. A study has been made 
of sterling rates during those two years. The accompanying charts 
(Charts II and III) and tables (Tables XI and XII) present the neces- 
sary data upon which’ to base our discussion. The tables show the 
closing weekly sterling rates for 60 day D/A commercial bills on banks, 
60 day bankers’ drafts, sight bills, and cables; the spread between 
the sight rate and the other three rates; the average call rate for money 
in the New York market for each week taken from the Financial 
Review (New York); the discount rate in the London money market 
for three months’ bills, taken from the London Economist; the 
discount margin calculated weekly by the London Economist, show- 
ing how much higher or lower the London open market discount 
rate for three months’ bills is than the New York call rate; and, finally, 
the deposit allowance rate in London. 


TABLE XI—OctToBER, 1907, TO SEPTEMBER, 1908 























DATE STERLING RATES SPREAD = S 8 
& LS S RS 
Siss 5 Ss 
3 = || 2s = Sx 
; 3 Sz Q maps 
Cle 2) Sea 
af a = 2 is 5 
S 5 | 8a So es 
= Q 
Oct. 4.8190]4.8240]4.8580] 4.8680}| . 5 113 15/16|| 1/16 below]|3 
4.8210]4.8235|4.8625|4.8685 5 1141/8 || 5/8 abovel|3 — 
4.8210] 4.86 5 1/4 3/8 |/r 5/8 below||3 — 
4-7675|4-7775|4.8225]4.8650]|. ‘ . 40 1145/8 {115 3/8 “ 113 
Nov. 4.8675|4.885 |}. : : 5° ||5 11/16}|11/16 abovel|4 
4.7875]4.8575|4.8825|| . 22 116 3/4 3/4 Ree 
4.8775|4.9075]}. ; . 10 }/6 7/8 7/8 eae 
4.795 |4.8710]4.9025]]|. : ; 10 ||6 7/8 1/8 below }|4 
4-707514.8660]/4.88 |]. 3 ; 7 1161/8 |/3 1/8 abovell4 
Dec. : 4.8050]4.86 6 IIs 3/4 Perms Ast | 
4-7975|4.8560]4.87 ‘ : ; 18 ||6 2 ere | Pk 
4.8025|4-.810 |4.86 12 |15 7/8 |13 1/8 below||4 
4.785 {4-795 14.845 |4.8675]|. . ¢ 20 116 2 Oe 
Jan. ; 4.80351 4.8530]4.8630]]. : : Io |{5 2 “sealla 
4.8115]4.8550]4.8605]]|. ; : 6 }14 9/16 || 1/16 abovel]4 
4.8225]4.8275|4.8670]4.8725]]. . 4141/4 |It 1/4 “ |[3% 
4.8325|4.8365|4.87 2 1135/8 |jr 5/8 “ {12% 
Feb. 4.8325|4-8370]4.868514.8730]|. : : t 3/4ig 1/2 lit r/2 “ Way 
4.8635}4.8665]]. : : I 7/8}13 3/16 |it 13/16“ ||2% 
4.8190]4.8230]4.8585|4.8615]]. : ; t7/8||3 3/4 |\r 3/4 “ 2% 
4.8290]4.8340]4.8665]4.8705 ES/4||s 2/3. [it 3/4 ae 
4.8325|4.8350]4.867014.8720 L 3/4)|3 5/16 |{r o/t 6S =jl2% 
Mch. 4.8312]4.834514.8635]4.8660]| . ; L 7/8113 I eed | 
4.8275]4.8315]4.8590]4.8615 t 7/8||2 15/16||15/16 ‘‘ |l2 
4.8312]4.8340]4.86 1 7/8}}2 11/16}|11/16 “fir 
4.830514.8385|4.8630]4.8655 25/8 7/8 above||14 
Apr. : 4.8425]4.8646]4.8675]]. : rt 5/8\|2 1/2 3/4) oe eae 
4.8680]4.87 L 3/4||2 7/16 |\15/16 “ |ir4 
4.8475]4.87 10]4.8750 L1/2|j2 5/8 jit 1/8 “ |{r% 
4.8445|4.8480] 4.87 30]4.8760 I 3/4||2 11/16}}15/16  “ 1% 
May 4.8420]4.8435]4.8690]4.8715]]. . : t 7/8\||2 5/8 sous 1% 
4.845 14.8490]4.8720]4.8770 L 3/4|}2 3/8 3/8 . ees 
4.8480] 4.85 10]4.8705|4.8730 L 3/4||2 1/16 || 5/16 “ irl 
4.848514.8525|4.8710]4.87 I 1/2i|x 15/16] 3/16“ |r 
4.85 2014.8555|4.8715]4.8740 I 5/8lir 9/16 || 3/16 below}|z 
June ; .8545]4.8690]4.87 20]|. : ; f r/2aiir 5/10 | 3/16 eee 
4.8485]4.8530] 4.8680] 4.8705 I 5/8||x 1/2 3/1685 I 
4.852514.8540]4.8685|4.87 1/2||x 1/4 tifa. (ee 
4.8535]4.8569]4.8695/4.8720 1/2}|r 5/16 || 3/16 “ fix 
July 4.8540]4.8575]4.8699]4.8710]|. , ; r/2}|r 1/8 1/8 above}|tr 
4.8540]4.8570]4.869514.8715 1/4}|z 3/16 |] 1/16 below]|1 
4.8575]4.8695]4.87 10]| . : r/4]it 1/4 t/q aie 
4.852514.867514.8695]|. ‘ ¢ 1/4l\t 3/8 1/8 above||tr 
Aug. ‘ 4.8525]4.8685]4.8705]|. : ; 1/8}|r 3/8 1/3. 7" I 
4.864514 .8660]]. ; : t 3/8 io8 I 
: 4.8640]4 .8660]]. : : 1/8||x 7/16 }|13/16 below]|r 
4.842514.8405|4.86 t 5/16 || 5/16 abovellr 
4.8375|4.842514.857514.86 |}. : : 1/8||x 7/16 |] 3/16“ I 
Sept. 4.8425|4.845014.86 17/16 lisaht64 eas 
4.845514.8490]4.864514.8670]]. ; : t 1/4]{ 9/16 || 7/16 below||1 
4.8475|4.8505]4.862514.86065]]. : : I 3/4|[r 3/8 1/8 below]|r 
4.846514.8490]4.8635|4.8655]||. 5 : t/4l|jr 3/8 3/8 above}|tr 


TABLE XII—JAnvary TO DECEMBER, 1913 








DATE 


Mo. 





Jan. 


Feb. 


Mar. 


Apr. 


May 


June 


July 


Aug. 


Sept. 


Oct. 


Nov. 


Dec. 


STERLING RATES 


Ww 
> 











2114.81 |4.8315]4 .8660]4.8700 
g||4.8t [4.832514 .8650]/4.86905 
16]/4.8r |4.8300]4.8645]4.8680 
23114.8r |4.8285]4.862514.8660 
30]|4.805 |[4.8255]4.8575|4.8610 
6||4.805 |4.8230]4 .8555]4.8590 













4.796214.8190] 4 .854514.8585 
4.7962]4.8180]4 .858514.8635 
4.7912|4.8160] 4 .8555]4.8605 
4.7875]4.8100]4 .8520]4.8570 
4-7875|4.8075]|4.8510}4.8555 
4.7825|4.8005]4.85 10]4.8560 
4.7825|4.804514.8495|4.8540 
4.7875}4.8100]4.8545]4.8590 
4.7037)4.8100]4.8545|4.8595 
4.7875|4.808514.8525|4.8580 
4-7875}4-8100] 4 .8535]4-8595 
4.7887|4.8090]4.8540|4.8500 
4-7912]4.8090] 4.8535|4-8590 
4.7912'4.810014.852014.8605 


SPREAD 


.0665 
.0588 
0025 
.0598 
. 0630 
.0638 
0625 
.0045 
.0638 
.0625 
.0680 
06045 
.O615 
.580 

.520 

.0528 
.0490 
.0558 
.0488 
.O513 
.O515 
.0520 
.0550 
.0595 
.0573 
.0570 
0618 
.0588 
.0560 
.0550 
.0560 
.0550 
-0545 
.0525 
.0525 
.O505 
.0528 
-0575 
.0583 
0023 
.0643 
.0045 
.0635 
.0085 
.0670 
.0670 
.0608 
.0650 
.0660 
.0653 
0623 
.0608 


37-2 


-0435 
.0385 
.O4I5 
.O4I10 
.0420 
.0425 
-0435 
.0440 
.O440 
.0425 
.O450 
.O450 
.0400 
.0380 
.0370 
.0340 
0335 
.0370 
.0340 
-0355 
.0340 
+0345 
.0390 
.0390 
.0385 
.0370 
.0390 
.0385 
-0355}]. 
-0355 
0345 
.0325 
0345 
.0340 
.0320 
.0325 
0335 
-0375 
-0355 
.O405 
0395 
.0420 
0435 
-0445 
.0450 
-0445 
-0445 
.0440 
-0435 
.0450 
-0445 
.0420 


.0045 
.0040 
.0045 
.0005 
.0955 
.cob0 
.0005 
.0070 
0080 
0080 
.0080 
.COgo 
.0085 
.0055 
sOOS5 
.0940 
. 0030 
.0035 
.0040 
.0040 
.0025 
.0035 
. 0030 
. 0030 
.0045 
.0080 
.0045 
.0050 


0050 


.0050 
.0040 
.0040 
.0035 
.0035 
.0035 
.0035 
.0030 
.0035 
.0040 
.0050 
.0050 
.0950 
.0045 
.0950 
.0045 
.0045 
.09050 
.0055 
0000 
.0950 
.0055 
0085 


N.Y. Call Rate 


5 1/8 
27/8 
2 3/4 
25/8 
2 3/4 
25/8 
3 7/8 
3 5/8 
3 1/8 
3 3/8 
4 1/2 
4 1/2 
4 3/8 
4 7/8 
3 3/4 


2 3/4 
2 3/4 
25/8 
27/8 
2 3/4 
2 3/4 
2 3/4 
2 E/2 


Ro NNN NH NN NNN DN 
ei 
oo 
iN) 


London Open Market 
Discount Rate 


4 9/16 
4 7/16 
4 9/16 
4 5/8 

4 3/4 

4 3/4 

4 13/16 
4 13/16 
4 3/4 

4 3/4 

4 3/4 

4 7/8 
45/8 

4 5/16 
4 1/16 
3 5/8 

3 9/16 
3 15/16 
3 9/16 
3 3/4 

3 9/16 
3 11/16 
4 3/16 
4 1/4 

4 1/4 

4 1/4 

4 1/4 

4 1/4 

4 

4 

4 

3 7/8 

3 13/16 
3 13/16 
3 5/8 

3 5/8 

3 eb) 2 

3 15/16 
4 1/8 

4 11/16 
4 3/4 
47/8 
47/8 


4 15/16 
4 15/16 


A 3/4 
4 7/8 
4 13/16 
4 15/16 
4 3/4 


Economist Difference 


I 13/16 “ 


I 
2 
i 


7/8 


7/8 


13/16 


[ 
I 
I 


5/16 
3/4 
3/4 


1/8 below 
1/8 above 


1/8 


5/16 
5/16 


7/8 


13/16 


uf 


3/16 


13/16 


I 


7/8 
1/16 


15/16 


1 7/16 


2 
2 
2 
2 
2 
I 
is 
- 
I 
I 
di 
T 


I 


1/4 
1/4 


1/4 above 


1/4 
1/4 
3/4 
1/2 
3/4 
1/2 
9/16 
9/16 
1/4 
7/8 


15/16 


I 


3/8 


6c 
6c 
ce 
73 
ce 
“ec 


“ce 


“cc 
ce 
ce 


‘ce 


“ce 


“c 
“cc 
ce 
(73 
cc 


(73 


“e 


T1110. 


I 
I 
I 


7/8 
3/8 
7/8 
7/8 


15/16 


I 
2 


3/16 
1/2 
1/8 


5/8 below 


11/16 
11/16 below |13% 


1 1/5 above 


“cc 


“cc 


ifs 


“cc 


“ee 


Deposit Allowance 
Rate 


——ee Oe | 
— fj | ——<——s |J] ——_——___ | —____. — | | -_—_————————_ | | |] dL 


I 3/16 below 
I 11/16 above 


3%4% 
3% 

3 
3% 
3% 
3% 
3% 
3% 
3% 
34 
34 
34 


34 


3% 
3% 


me Net 


BSSNANANISNERNERNS 


LS) 


Se Ne Net 


BRHWwWWWWWWW WWW WW WWW WW WW WW WWW WwW WW WwW WW W 


al 


314 
3 ly 


34 
3% 


362 DOMESTIC AND FOREIGN EXCHANGE 


These data are plotted on Charts II and III. A glance at either 
of the charts is sufficient to show that no close or proportionate corre- 
spondence exists between any of the spreads and the New York call 
rate, the London discount rate, the Economist’s “difference” or 
discount-margin, if we may call it such, or the London deposit allow- 
ance rate. Any of the latter may rise or decline and the spread may 
remain the same or move in a direction opposite to that which the 
above theory holds should be the case. There are, of course, a number 
of instances in which the spread moves in harmony with the theory 


ee eed OG 
ea VAT AN SPE e DTS] S ae en ace ee 









0 Oe 7 il a 
al) INV ONAN LT AAS ee 
lal ZN] NI IWANGF | TT TT TT SS ze 
CAP Oh AA Ea ee Lh 
PANT | NAY LAT TS SNR Ne 
PVE eR eet pot 

et ZT ee el a 
RRB ARR ee 

RL IN LAAN A DLT Cs ee ere 
YB SIR a NS 





Yh NP 
A TT 
BSN Ra ae 375 ON ST 
ES 2250) 
Ce Re A a 















CuHartT II 


Spread of sterling rates, 1907 


above outlined; but is a theory to be justified by only occasional cor- 
relations? 

Picking out a few instances for the purpose of illustrating how con- 
trariwise the spread may move, and choosing the normal year 1913 
in order to avoid the criticism that no rule holds good under abnormal 
conditions, let us take February 1, 1913. The London open market 
discount rate was 4 3/4 per cent; the New York call rate was 2 3/4 per 
cent; the Economist’s difference was 2 per cent, and the London 
deposit allowance rate was 3 }4 percent. The spread from the sight 


RATES OF FOREIGN EXCHANGE 363 


rate for cables was 55 points; for 60 day bankers’ bills, 420 points; 
and for 60 day D/A commercial bills, 630 points. A week later the 
London open market discount rate was still 4 3/4 per cent; the New 
York call rate had dropped to 2 5/8 per cent; the Economist 
“difference” was 1 7/8 per cent, and the London deposit allowance 
rate was still 314 per cent. The cable spread had increased to 60 
points; the 60 day bankers’ bill spread had increased to 425, and the 
60-day D/A commercial bill spread had increased to 638—all contrary 
to our theory. A week later, February 15, with a very slight increase 


re) | 
ee eee Oe 
Bee eee ee 





Cuart IIT 
Spread of sterling rates, 1913 


(x/16 per cent) in the London discount rate, an increase of 1 2/8 per 
cent in the New York call rate, a decrease of 1 1/16 per cent in the 
Economist's “difference,” and with no change in the London de- 
posit allowance, there was a slight decrease in the spread of 60 day » 
D/A commercial bills, an increase in the spread of 60-day bankers’ 
bills, and an increase in the cable spread. 

Considering for a moment only the cable spread and its relation to 
the London deposit allowance rate, we note that from April 19, 1913, 
to September 27, 1913, the deposit allowance rate remained at 3 per 


364 DOMESTIC AND FOREIGN EXCHANGE 


cent yet the cable spread ranged from a maximum of 80 points to a 
minimum of 25 points, while from January 4, 1913, to April 12, 1913, 
and from October 4, 1913, to December 27, 1913, when the London 
deposit allowance rate was 31% per cent, the cable spread ranged from 
a maximum of go points to a minimum of 4o points. With the deposit 
allowance rate at 3 per cent, the spread (25 to 80 points) was twelve 
out of a possible twenty-four times within the range of the spread when 
the rate was 31% per cent (40 to go points), and with the rate at 314 
per cent, the spread (40 to go points) was 22 out of a possible 28 times 
within the range of the spread when the rate was 3 per cent (25 to 80 
points). (Chart IV.) If the deposit allowance rate in London is such 


Sprea a determining factor in the spread between the 
4 sight rate and the cable rate, surely there should 
$0 
30 be a much closer correlation than the above data 
70 disclose. 


A similar conclusion may be arrived at if a 
comparison is made between the maximum and 

Al minimum spread from the sight rate in the case 

am of the two types of long bills under discussion 

ur aeae and the discount rate for three months’ bills in the 

Deposit Allowance London open market. Chart V shows the greatest 

and the smallest spreads at varying rates of dis- 
CuarTIV count for the year 1913. The conclusion to be 

Relation between drawn is so evident that no discussion is needed. 
cable spread and Qne point of importance is disclosed by this chart, 
yes ee MS however, and that is that as the rate of discount 
rate in London : : 

rises the spread tends to increase, but by no 
means proportionately. 

A glance at Charts II and III is sufficient to show that there is no 
apparent correlation between either the New York call money rate or 
the Economist’s “difference,” on the one hand, and the spreads either 
of cables or of long bills on the other. 

To conclude, and we must reach some conclusion in this attempt to 
apply theory to the practical world of the exchanges—all that can be 
said is that as the foreign open market discount rate rises there is a 
tendency for the spread between sight bills and long bills to become 
greater, but by no means proportionately greater. In fact, basing 
one’s conclusions upon the above discussion, might not one be justified 
in disagreeing with Whitaker’s statement in connection with long 


RATES OF FOREIGN EXCHANGE 365 


bills that “In an ordinary case perhaps 9/ro of the spread will be due 
to discount”’? Also we may conclude that as the foreign deposit 
allowance rate rises there is a very slight tendency for the spread 
between sight bills and cables to become greater. This is all that can 
be justly claimed in view of the data presented herewith. 

In the transactions of the market dealers and the public are not 
on a basis of equality when it comes to bargaining. The public knows 
nothing of foreign discount rates or of the deposit allowance rate 
that is being paid on accounts 
abroad. When a_ business 
man wants a cable with which 
to make a payment, he usually 
wants it badly and does not 
stop to ask why it is that 
the banker charges a certain 
rate forit. Likewise when an 
exporter has exchange to sell, 
he does not stop to calculate 
why the banker gives him a 
certain rate. The banker will 
charge what the market will 
bear, unless he himself is in 

3% 4 44 4h, 
great need of funds at home Percent Discount Rate 
and is selling exchange for the CHART V 
purpose of transferring his Maximum and minimum spread of 


foreign account to his own sixty day D/A commercial bills and 


bankers’ bills at varying rates of dis- 
vaults. When he buys ex- count in London, 1913. Upper portion 
change he buys it at what the of chart relates to spread of sixty day 


market will stand, paying for D/A commercial bills; lower portion of 
it no more than necessary in per een aes to spread of sixty day 
order to get the exchange with 

which to build up his foreign accounts. As was stated above, the 
banker has three elements to consider in his money-making activities 
as an exchange dealer, viz., his funds, the money rates abroad, in- 
cluding the deposit allowance rate, and the money rates at home. He 
will lose on some deals; he will gain on others. To a great extent he 
works by rule of thumb and not with the exacting foresight and 
finesse that many exchange writers would have us believe to be the 


case. 





366 DOMESTIC AND FOREIGN EXCHANGE 


V. Financial Standing of Parties. The standing and reputation 
of the drawer and also that of the importer, and if the importer and 
the acceptor are two different parties then also that of the acceptor, 
greatly affect the rate of exchange that bankers will pay for bills of 
exchange. If the drawer has a very unsatisfactory commercial or 
financial standing the bank will pay a lower rate for his bills than for 
those of firms having an excellent reputation. Banks are usually very 
careful about ascertaining the financial rating of the drawer or ex- 
porter. Not only do they use their own credit files for this purpose, 
some of the larger banks having a very complete credit department, 
but they also consult the reports of rating bureaus such as Dun’s, 
Bradstreet’s, etc. The standing of the importer or acceptor is also 
of importance because it is the importer or acceptor who is obligated 
to pay the draft at maturity. Where the acceptor is a bank, no ques- 
tion regarding the bank’s ability to pay will ordinarily arise. But 
where the acceptor is an importing foreign firm, as is the case in all 
trade acceptances, its financial standing is of course important. Trade 
acceptances drawn and accepted by firms of unquestioned standing 
are known in England as “fine trade bills” and are discounted at a 
lower rate than are other classes of trade acceptances—consequently 
they command a higher rate when being sold by the drawer to his 
bank. Bank acceptances will sell for higher rates than trade accept- 
ances because of the unquestioned financial status of the acceptor 
and also because they are discounted abroad at a lower rate of dis- 
count.! , 

We have already dealt with the importance of the standing 
of the drawer in connection with our discussion of clean bills of ex- 
change. Banks will ordinarily purchase clean bills only when drawn by 
first class reputable exporting firms. Some European banks make 
it a practice never to deal in clean bills. The rates paid by banks to 
exporters for such bills are always lower than the rates paid for docu- 
mentary bills, the reason being that the risk is greater because clean 
bills have no security other than the reputation of the drawer. Clean 
bills issued by banks on their accounts abroad command, as one can 
well surmise, the highest rates that are paid for drafts of any sort 
and are discounted abroad at the prevailing market rate, while those 
drawn against firms of excellent reputation are discounted at a rate 


1To cite an example: on June 3, 1808, sterling bank acceptance rates were 4.8334 @ 
4.84: sterling trade acceptance rates were 4.834 @ 4.83 4%. 


RATES OF FOREIGN EXCHANGE 367 


about 34 per cent higher. Demand drafts drawn by exporters and 
others who are not exchange dealers but who possess foreign bank 
accounts, are always quoted at lower rates than prime bankers’ bills. 
It is also interesting to note that the bills of first-class small firms will 
sell for a little less than will those of first-class large firms, depending 
upon the market’s estimate of the drawer’s credit. 

VI. Character of Goods Drawn Against. If the exporter’s drafts 
have been drawn against a shipment of staple commodities, such as 
grain, cotton, raw materials, etc., other things being equal his drafts 
will sell for more than if drawn against specialties, such as clocks, 
phonographs, musical instruments, etc. The reason is that if any 
difficulty should arise in connection with the transaction and make it 
necessary for the holder of the bill of exchange to sell the goods at 
auction he would be able to realize on a shipment of staple com- 
modities approximately the face value of the draft, while in the case 
of specialties nothing like their listed value could be obtained. 

VIL. Amount of Drafts Outstanding. Just as in the earlier part 
of our discussion we have seen that London discount houses watch 
very carefully the total amount of bills accepted by any London firm, 
and if the firm has assumed too heavy a liability in connection there- 
with the discount houses charge a higher discount rate than usual, 
so we find that in our own market if banks issue too many finance 
or loan bills they will be compelled to sell them for a little lower rate, 
probably ten to fifteen points less, than that which is being paid for 
the bills of other bankers who have issued a smaller amount. The 
same policy is followed in connection with the amount of bills drawn 
by an exporting firm. The purchasing bank is always desirous of as- 
certaining the extent of the liability that the exporting firm has as- 
sumed. If too heavy a burden has been incurred the bills command 
a lower rate. The rate paid for “pig on pork”’ bills is universally a 
little less than that paid for two-name paper, because the former are 
actually, as we have seen, only single-name paper. 

VIII. Miscellaneous Influences. Finally, war and rumors of war, 
political developments of various kinds, the death of international 
financiers or rulers,! “sentiment” of one sort or another, and a host 
of miscellaneous causes affect exchange rates favorably or unfavorably 
as the case may be. For many years past, for example, the Balkan 


1Qn January 5s, 1916, the rumored death of the Kaiser of Germany caused a decline in 
the mark quotation in New York, 


368 DOMESTIC AND FOREIGN EXCHANGE 


situation has been a disturbing factor in the field of the exchanges. 
Again, in September, 1908, a great deal of political uncertainty was 
caused in Europe by Germany’s attitude on the Morocco question 
and brought about the extensive selling of securities in the United 
States by Europeans who were desirous of calling in their funds in 
order to have them handy if war were declared. An instance of an- 
other character is found in the case of the return of King Constantine 
to the Grecian throne in November, 1920. The Allies refused recog- 
nition and did not allow Greece to draw against the balance of unused 
credits which had been advanced in connection with her participation 
in the World War. They also levied a sort of financial boycott, with 
the result that drachmas, which had been well maintained up to 1919 
fell rapidly, reaching 7.50 cents in February, 1921, 5.60 cents in May, 
and about 4 cents in December (par being 19.294 cents). Large 
military operations, the difficulty of absorbing the new territories 
added under the peace settlement, together with the issuance of mil- 
lions of inconvertible paper drachmas, also played their part in weaken- 
ing the rate. In the latter part of November, 1921, sterling and con- 
tinental rates stiffened noticeably, due, so it was claimed, almost 
solely “to the sentimental influence of the proposal to grant Germany 
a two-year moratorium. Bankers generally expressed approval of the 
plan on the ground that Germany must soon default if regular pay- 
ments are insisted upon.” ! 

In brief, it may be said that almost any political or economic de- 
velopment or event that is likely to affect international relations is 
bound to exert some influence on the course of exchange rates. This 
is the main reason why every international banker is vitally interested 
in all such matters. He must ever be on his guard to take advantage 
of favorable situations and to avoid those that are likely to result in 
losses. He has to be possessed not only of excellent judgment but 
at the same time also of a sense of prophecy. The difficulties and un- 
certainties which he has to meet in gauging the direction in which 
rates may tend in turbulent times are uniquely evidenced by an in- 
stance that occurred during the early stages of the World War. Ger- 
many declared a war zone around Great Britain, and many dealers 
felt that exchange rates would inevitably decline. On the contrary, 
however, rates rose slightly on the theory that exports from the United 
States to England would be restricted and would result in a reduced 


1Commercial and Financial Chronicle, December 3, 1921, p. 2350. 


RATES OF FOREIGN EXCHANGE 369 


supply of bills of exchange. As a result of wrong guesses, it is said 
that many of our international bankers suffered losses amounting 
in some cases to millions of dollars when the exchange market went 
to pieces following the “unpegging”’ of sterling exchange in the spring 
of 1919. 

The above discussion has had to do with the more important factors 
affecting exchange rates under average or normal conditions. In a 
period of world war, such as we experienced from 1914 to 1918, those 
factors that are normally of great influence recede into the background 
and become less important, only to be superseded by other factors 
which war conditions make possible and seemingly inevitable. The 
World War caused the abandonment of the gold standard by all of 
the European countries and resulted in the issuance of huge amounts 
of paper money. Gold commanded a premium, and the cost of living 
soared to unheard of levels. The exchanges necessarily depreciated 
to a startling degree. Artificial methods of stabilization have also 
interfered with the normal functioning of the market. These matters 
and their various ramifications, as well as the unusual fluctuations 
that have characterized the exchanges since 1914, will be more fully 
discussed in subsequent chapters. 


CHAPTER XI 
GOLD AND GOLD MOVEMENTS 


Any contact with the field of the exchanges or with foreign trade 
reveals the fact that gold and silver are continually shipped back and 
forth between the nations of the world, regardless of whether or not 
those nations are on a gold, silver, paper, or gold exchange standard 
basis. At times these shipments are made even at a loss because of 
the requirements of the financial or trade situation, although they 
are usually made only because of the possibility of speculative profits. 
Gold is not always exported to pay off foreign indebtedness, as some 
might think. Bankers who owe nothing abroad may export gold to a 
correspondent in London because, the costs of shipment being low 
and the rates at which they can sell their exchange being high, they 
see a chance to profit by selling drafts against the gold exported. A 
banker may desire to build up his account in London and finds that he 
can do it much more cheaply by sending gold to Paris or to some other 
center where his correspondent, acting under instructions, will use 
the gold to buy exchange on London so that the New York banker 
will be able to sell drafts against the London account thus built up. 
Such a transaction, of course, will occur only when exchange in New 
York on London is fairly high and in Paris on London is fairly 
low, and also when at the same time the rate between New York 
and Paris is too high to make the purchase of French exchange 
advisable. | 

The financial and business worlds are more particularly concerned 
with shipments of gold, although as between some countries the silver 
market and shipments of silver bulk large in importance. Gold, how- 
ever, is the metal in terms of which the value of practically all the 
wealth and trade of the world is measured. It forms the basis of 
our greatest banking and monetary systems. Trade balances, obli- 
gations of one government to another, private debts, all are paid by 
means of it or by credit instruments directly or indirectly based on it. 

37° 


GOLD AND GOLD MOVEMENTS 371 


A nation’s demand for gold varies from day to day and from week to 
week, just as a banker’s need of gold for reserves or other purposes 
varies from time to time. The total stock of gold in the world, avail- 
able for monetary purposes, is variously estimated at about $9,500,- 
000,000. This amount is so extremely small compared to the tremen- 
dous demands made upon it, and the output each year, estimated be- 
fore the World War at about $450,000,000 per year, is so limited, that 
in normal times the fluctuating demands of the various countries for 
the metal, provided no obstacles are placed in its way, cause it to flow 
freely from one part of the world to another, apparently seeking its 
level and satisfying, at least temporarily, the requirements of the 
country that needs it most. Being a non-perishable and constantly 
treasured commodity, the same gold may journey back and forth 
across the ocean several times a year, just as a National bank note 
may be sent back and forth between San Francisco and New York 
several times a year in payment of various obligations. As there are 
certain forces at work in the United States that cause the bank note 
to be sent to and from New York, so in international relations there 
are factors that cause gold to flow from one section of the world to 
another as occasion demands. If a country has an insufficient supply 
of gold, certain economic forces, if allowed to work freely, will bring 
it gold from other countries, while if it has too much gold, similar 
forces will cause it to be exported.!_ The forces concerned are primarily 
those that we have been discussing in connection with our examination 
of what it is that goes to make up the supply of and the demand for 
exchange. 

Just as the rates of exchange in the market are “hinged”’ onto the 
sight rate, so we find that the sight rate is also the basis on which 
calculations are made as to the advisability of gold movements. To 
lay down then, at the beginning of the chapter, the general thesis or 
principle from which our discussion proceeds, we may say in brief that 
when the sight rate of exchange rises to too high a level gold will flow 
out of the country because it will pay to ship gold rather than to buy 
exchange at high rates. On the other hand, when the sight rate falls 
to too low a level gold will flow into the country because it will be 
profitable first, for foreigners to send gold rather than exchange; 
second, for domestic merchants to have gold sent them rather than 


1 Whether or not a country can ever have too much gold will be discussed in subsequent 
sections of this chapter. 


372 DOMESTIC AND FOREIGN EXCHANGE 


to draw on the foreign importer and be compelled to sell their exchange 
at such a low figure; and, third, for domestic bankers to buy exchange 
at low rates, send it abroad for discount, get gold, and import it. While 
in general, we are correct in saying that in normal times the gold move- 
ment is dependent primarily upon the position of the sight rate, never- 
theless we must also remember, as we have noted earlier, that the gold 
movement in its turn affects the sight rate. 

There is as much necessity for providing means whereby gold may 
readily and easily flow from one part of the world to another as there 
is for the easy and ready flow of gold or funds in any form from one 
section of our country toanother. Under our national banking system 
it was not possible for funds to be shipped with any degree of facility 
from East to West or vice versa, although gold and other forms of 
money were continually being sent back and forth. As a consequence 
of the difficulties, expense, and loss of time attending domestic trans- 
fers of gold, money rates in one section of the country were frequently 
widely divergent from those existing in another. With the introduction 
of the Federal Reserve System and the inauguration of the Gold Settle- 
ment Fund the situation was completely revolutionized. Federal 
Reserve banks now keep a large portion of their gold holdings with 
the Gold Settlement Fund in Washington and shift them, as the 
occasion demands, from one Federal Reserve bank to another merely 
by means of a book entry. Thus it is, that, figuratively speaking, 
gold is shipped instantly from one section of the country to another 
as the need arises. Since the inauguration of this practice a great 
saving in time and costs has been effected and sectional money rates 
have tended more and more to be on a par with one another. In the 
field of international dealings, however, transfers of gold and funds 
are not so easily and quickly effected. We have not as yet established 
an International Gold Settlement Fund, although one has been pro- 
posed by some of our prominent financiers. We are therefore com- 
pelled to ship gold and silver back and forth across the waters for the 
settlement of international obligations, although, as we shall see later, 
it sometimes happens that the gold is not shipped but is merely “ear- 
marked,” i. e., set aside to the credit of the foreign party and held in 
the debtor country until orders are received for its disposal. Nor- 
mally, however, gold is actually shipped from one part of the world 
to another, entailing expenses of freight, insurance, interest, labor, 
etc: 


GOLD AND GOLD MOVEMENTS 373 


For many years London has been considered the great international 
market for both gold and silver, but there is some question as to 
whether or not it has in times past been the only free gold market. In 
fact, some authors question whether or not it has ever been a free gold 
market. English writers before the World War? universally main- 
tained that it was the only free gold market because the Bank of Eng- 
land stood ready at any time, as the storehouse of the world’s gold, 
to part with gold sovereigns in return for Bank of England notes, thus 
making gold always available for export. They also cited the measures 
availed of at times by the Bank of France and the Reichsbank of 
Germany to prevent the outflow of gold when such was deemed to be 
detrimental to the financial interests of France or Germany respec- 
tively. It was claimed that New York was not a free gold market be- 
cause gold could be obtained from the United States Treasury only 
by presenting gold certificates, and that even then the Treasury was 
not compelled to sell gold bars in return for gold certificates or any- 
thing else unless it wanted to do so. In England, before the war, gold 
coins and Bank of England notes were legal tender. Under the Act 
of August 6, 1914, however, the government was authorized to issue 
£1 and tos. notes (called ‘“Bradbury’s”’) redeemable at the Bank of 
England in gold. English writers have urged that a person who de- 
sired to obtain gold for export could demand payment from his debtors 
in sovereigns, Bank of England notes, or government paper money. 
He could take the latter two kinds of money and demand gold from 
the Bank of England, and so get gold for export. Up to the time of 
the declaration of war in 1914, it was true that the exporter could 
get all the sovereigns, but sovereigns only, that he desired by following 
the procedure outlined. But after the outbreak of the war, although 
the Bank could not legally refuse to redeem its notes or the government 
notes in sovereigns, yet the same end was actually attained by appeal- 
ing to the patriotism of the citizens, by placing gold exports under 
government control, by requiring licenses for gold shipments, and 
by various other devices. Down to the present time (April, 1922) 
London has not as yet resumed her former position as a gold 
market. | 

In the United States, four kinds of money, viz., gold coins, gold 
certificates, silver dollars, and Treasury (Sherman) notes of 1890, 
have full legal tender qualities under all conditions in the absence of 

1 Cf. especially Withers, ‘“‘Money Changing,” Chapter VIII. 


374 DOMESTIC AND FOREIGN EXCHANGE 


contract, whether it be payments by an individual to the government 
or vice versa, or payments between individuals, banks, etc. Other 
kinds of paper and metallic money possess varying degrees of legal 
tender qualities. Legally, the Secretary of the Treasury is required 
to maintain all of our money at a par with gold, which in times of a 
crisis might mean redemption in gold; but in normal times the law 
specifically requires that only gold certificates, Treasury notes, United 
States notes, and Federal Reserve notes! be redeemed in gold, al- 
though in practice the Treasury will normally redeem any kind of 
United States money in gold. Thus, as the reader can easily appreci- 
ate, it is not possible in times of stress or strain for the merchant to de- 
mand that his debtor pay his obligations in money that may be re- 
deemed in gold at the United States Treasury or at a Federal Reserve 
bank.? Technically, therefore, we do not now have, and never have 
had a free gold market in the sense that the English writers have used 
that term; but for all practical purposes, our market has been as free 
as, in fact in many regards freer than, that of London. Prior to the 
establishment of the Federal Reserve System we possessed no means 
of controlling the gold flow either into or out of our country. Gold 
went or came in response to the conditions prevailing in our own 
markets or in response to the policies followed by the central banks of 
foreign countries. If conditions were such that gold was expected to 
come to us, it might or might not come, depending upon what was 
happening abroad—primarily in England. If the financial situation 
were such that we would not ordinarily expect gold to flow out of our 
country, it still might go—again depending upon what action the 
foreign central banks might take to induce its exportation. A “‘free 
gold market,’ by the very connotation of the term, should imply a 
market where the forces of supply and demand work freely and without 
artificial restrictions. If the word had not been so greatly abused by 
our early /aissez-faire economists, one might say that a free market is 
one in which gold is allowed “aturally” to flow into or out of a 
country. We shall see, as the discussion proceeds, that in normal 
times the “free” (?) gold market of London has always been under 


1 Federal Reserve notes are redeemable in gold at the United States Treasury in Wash- 
ington, D. C., or in gold or lawful money (any kind of money issued by the United States 
government) at any Federal Reserve bank. 

2 The Federal Reserve banks now act as redemption agencies, the sub-treasuries by the 
law of May 29, 1920, having been discontinued and their powers and functions assigned to 
the Federal Reserve banks. 


GOLD AND GOLD MOVEMENTS 375 


the complete control of the Bank of England when it desired to assume 
that control, and that again and again by artificial means it has pre- 
vented or encouraged the gold movement as required by the interests 
of the London money market. That statement applies likewise to the 
gold markets of other European countries. It goes without saying 
that during the topsy-turvy conditions following the declaration of 
war in 1914 down to this date of writing (April, 1922), London has 
ceased to be—or even to claim that she is—a free gold market or the 
only free gold market in the world. Needless to say, this statement 
is not made with any feeling of malice or exultation, for all American 
economists appreciate the wonderful service to the world which London 
has performed in her former position of dominance, the assistance 
which she has rendered in times of financial strain, and the relative 
generosity with which she has shared her gold holdings with other 
countries, at times even to the detriment of her own financial in- 
terests. 

With the introduction of an open discount market in the United 
States following the inauguration of the Federal Reserve System and 
the adoption of a discount policy by the Federal Reserve banks as a 
possible means of controlling the gold flow, it is difficult to say to 
what extent our gold market will in the future be similar to that of 

London. As yet we have had no opportunity of seeing what possible 
effects our proposed methods may have on specie movements, because, 
with the exception of the short time during which our foreign ex- 
changes were, aS a war measure, completely under the control of the 
Federal Reserve Board, we have had no occasion to attempt a manipu- 
lation of the gold flow in either direction. The developments of the 
future alone will disclose to what extent our gold market is capable 
of remaining a really free gold market. 

London has been the one important center to which the new gold 
of the world, especially that produced in South Africa and Australia, 
has been shipped for sale. More than one-half of the annual gold 
output is mined in countries that have little or no use of it for monetary 
purposes. In 1913, to take a presumably normal year, Africa pro- 
duced over 40 per cent of the world’s supply, the various provinces 
of Australasia more than 12 per cent, and the United States, Canada, 
and Mexico about 19 per cent, 4 per cent, and 4 per cent respectively. 
In 1913 the total output was $459,941,100; in 1920, because of con- 
ditions existing during and after the war, chiefly the increased cost of 


376 DOMESTIC AND FOREIGN EXCHANGE 


mining, it fell to $337,951,000.! The greater part of this gold is shipped 
to London where it is auctioned off in the gold market held, in normal 
times every Monday morning. The buyers represent a small group 
of foreign and domestic banks and bankers. As the various lots of 
gold are put up at auction they are bid for in accordance with the 
needs of the buyers and the possibility of securing a profit on the 
transaction. If there are no bidders, the gold is usually disposed of 
by the producer’s agent to the Bank of England, which by law is 
compelled to purchase it at a minimum price of £3 17s. od. (77s. gd.) 
per ounce .916 2/3 (11/r2ths) fine. It may pay more than this price 
if it desires to do so and, before the war, when sorely in need of the 
metal for reserve purposes, it was known to pay as high as 77s. 10d. 
An ounce of gold 11/12ths fine can be coined into £3 17s. 10%d. (77s. 
10/4d.). The difference (114d.) between that sum and the minimum 
price of the Bank of England represents a discount or demurrage 
charge which goes to the Bank to reimburse it for the loss of interest 
which it assumes by advancing cash to the seller and then having to 
wait fourteen to twenty days before receiving the minted gold from 
the Royal Mint. The Mint is compelled by law to receive gold at the 
fixed price of £3 17s. 104d. per ounce 11/r2ths fine, or £4 4s. 11 5/11. 
per ounce for pure gold, but the seller must wait from two to three 
weeks while the metal is being coined into sovereigns. Almost all 
the gold that is not disposed of to foreign buyers is sold to the Bank 
of England rather than to the Royal Mint. 

Inasmuch as an ounce of gold 11/12ths fine when minted yields 77s. 
1old., it is maintained by some that the market price cannot rise 
above that figure. This is not the case, however, for even before the 
World War there were times when, as during 1907, we were drawing 
so much gold from the English market that it reached the price of 
78s. 2d. During the war, the English government completely con- 


1GOLD PRODUCTION OF THE WORLD 


1913 I9IQ 1920* 

United Statesiia... pavace.t deat tewas $ 88,884,000 $ 60,333,000 $ 51,098,000 
CCATIACIAS walks cso AGitate cy ook wre acne Deen 16,599,000 15,859,000 16,011,000 
RUBS ogc henge aoe) Sk ne ee 26,508,000 12,000,000 4,867,000 
SCD GALPICE . Gels natne hese ck ee eae 196,160,000 184,498,000 180,065,000 
PUG EA RTD ys De ote a re cuneate rae 53,113,000 26,112,000 24,401,000 
PSPUPISES DOCG, cole ak te eretentals orn eee 12,178,000 10,486,000 9,194,000 
All Otierk hy.5.% veucw bento erates 66,499,000 55,878,000 52,315,000 

Total! Sit. rea eee $459,941,000 $365,166,000 $337,951,000 


* Estimates of London Economist, February 19, 1921 


GOLD AND GOLD MOVEMENTS 377 


trolled the London situation, and no data are available as to what 
prices were actually paid for gold; but it is known that South African 
producers were compelled by the government to sell their gold only 
in England and at the customarily fixed price of 77s. 10!4d. for gold 
11/12ths fine. During the war every effort was made by the govern- 
ment to conserve the gold holdings of the nation. Gold exports were 
under its complete control, being made only on its behalf. Strangely 
enough, gold imports (either manufactured or non-manufactured gold) 
were prohibited by Royal Proclamation on December 5, 1916, unless 
such gold were consigned for delivery and sale to the Bank of England.* 
Sales of gold in the open market were abandoned. Gold disappeared 
_ from circulation, and the Bank of England, though legally compelled 
to redeem its notes in gold, resisted most strenuously the demands 
of those who made such requests. Lately I have been informed by a 
prominent English banker that it has not been possible to get gold in 
any amount from the Bank. This party stated that a sovereign or 
two might be obtained on the claim that it was to be used as “a gift 
to the bride,” or for similar purposes, but even then, the recipient 
might be followed by detectives to see that the gold was not used for 
some other purpose. 

We suffered from about the same sort of restrictions in the United 
States during the greater part of the war, even before our government 
took over the regulation of the exchanges. The Federal Reserve banks 
early mobilized our gold holdings, and so effectually was it done that 
gold practically disappeared from circulation. Banks, not being re- 
quired by law to pay out gold, acceded to the request of the Federal 
Reserve officials and did not do so. With us, however, the situation 
cleared up shortly after the Armistice and restrictions on gold export, 
import, or trading ceased with the abandonment of the control of the 
exchanges by the Federal Reserve Board on June 25, 1919.2 In Eng- 
land, however, some war restrictions still (April, 1922) remain. While 
it is technically true that the government of England did not legally 
prohibit exports of gold during the war, nevertheless all gold that was 

1It was stated that the reason for this proclamation was the desire of the government 
to secure control of all the gold flowing into England in order to be able to use it in financing 
its war needs rather than to have it used in the manufacture of jewelry, for which there 
was a great demand during the war. 

2 Gold, however, was not put back into circulation in the United States until in March, 
1922, when the Secretary of the Treasury notified the Federal Reserve banks that the need 


for complete mobilization of our gold holdings had ceased and that the Federal Reserve 
banks were at liberty to put as much gold back into circulation as they desired. 


378 DOMESTIC AND FOREIGN EXCHANGE 


shipped out went only as the result of government action. On March 
28, 1919, however, an Order in Council was issued under the Exporta- 
tion Prohibition Act of 1915, formally prohibiting the export of gold in 
any form and to any destination. In July, 1919, a slight modification 
of this order was made, permitting new gold which had been shipped to 
the London market to be exported provided a license therefor was 
obtained from the government. This was embodied into law on De- 
cember 23, 1920, through the enactment of the Gold and Silver Export 
Control Act, which not only prohibited, under heavy penalty, the ex- 
port of gold and silver coin or bullion from the United Kingdom ex- 
cept under a license granted by the Treasury, but also made it un- 
lawful for any person to “melt down, break up, or use otherwise than 
as currency, any gold or silver which is for the time being current 
in the United Kingdom or in any British possession or foreign coun- 
try.” 1 On September 12, 1919, war time restrictions on gold sales 
were lifted and gold trading was again resumed in the open market, 
the metal being sold to the highest bidder and exported only under 
license from the Treasury. Owing to active bidding, the price ad- 
vanced rapidly and went to about a 15 per cent premium. On Septem- 
ber 18 it rose to ggs. (per fine ounce), in early November to 1oos., on 
November 20 to 103S., on December 4 to r1o6s. 4d.; and the price at 
the close of the year stood at 1ogs. 8'%4d. Computing this closing rate 
at par ($4.8665), gold was actually selling in London for $26.67 per 
ounce 11/12ths fine as measured in terms of American money.” With 
pure gold procurable in the United States at a price of $20.6718 per 
ounce, one might expect that it would have paid an American banker 
to ship gold to England and procure in English money the equivalent 
of $27.094 per ounce (the price of $26.67 above was for an ounce of 
gold 11/12ths fine); but it must be remembered that with gold at a 
premium, England was not (and still is not) on a gold standard basis. 
Her government paper money and the notes of the Bank of England 
did not and no longer do bring their face value in gold. They are at a 
discount as measured in terms of gold. Hence the American exporter 
would have received paper money for his gold, an extra amount it is 
true, but it could not be redeemed in gold—and furthermore, owing to 
the depreciated value of the paper money it would not have purchased 


1This Act was designed to remain in effect until December 31, 1925. 

2In other words, if an American banker had sent an ounce of gold to England, he could 
have obtained 1ogs. 8'%d. in paper money for it. Converted into American money at the 
par rate of 4.8665 = £, 109s. 84d. equals $26.67. 


GOLD AND GOLD MOVEMENTS 379 


in England as much as an equal amount of gold. The premium 
on gold continues down to date (April, 1922), the price remaining 
almost constantly above 1oos. until the closing days of 1921, when it 
fell somewhat below that level. The significance of the premium on 
gold as affecting sterling rates will be discussed in a later portion of 
this volume.’ 

The order permitting the re-export of new gold sold in London came 
about primarily as a step taken by London to retain its position as the 
principal gold market of the world. With New York placing no re- 
strictions whatsoever upon the import or export of gold, London 
realized that something had to be done to prevent a flow of gold from 
the producers directly to New York, thence to be distributed over the 
world—a situation that would enable New York to displace London as 
the gold center. South African gold producers had complained that 
they were being compelled to sell in the London market at the pre-war 
price in spite of their greatly increased costs of production and threat- 
ened to close down their mines unless the government gave them either 
a bounty or a free market. The government therefore decided to es- 
tablish, as far as possible, a free market. The results justified the 
decision, and gold has continued to flow to London, and from London 
to various parts of the world, but principally to New York and India. 
The foreign market in which the gold exporting country’s exchange 


1 The price of gold per fine ounce at the opening of each month since the resumption of 
active trading in 1919 has been as follows: 


1919 
September 1 gos. November rg. 
October 1 99s. December 4 106s. 4d. 
1920 
January 1 togs. 814d. July 2 IO4S. 
February 5 127s. 4d. August 3 112s. 
March 2 I1gs. 6d. September 1 115s. 1d. 
April 3 105s. October 1 118s. 4d, 
May 1 107s. 6d. November 1 1109s. 2d. 
June 1 106s. 3d. December 1 1178s. 5d. 
1921 
January 3 EPSS: 1G. July 1 r1os. 1d, 
February I 107s. 2d. August 1 115s. 2d. 
March tr 105s. 10d. September 1 r1os. 4d. 
April 1 106s. 1d. October 1 Its. od. 
May 2 103s. 8d. November 1r_ toqs. 4d. 
June r 105s. god. December 1_ 102s. 3d. 
1922 
January 3 o7s. od. March 1 938. 3d. 
February 1 96s. 3d. April r 95s. 3d. 


2Cf. pp. 478-486. 


380 DOMESTIC AND FOREIGN EXCHANGE 


is at the greatest depreciation gets the gold because it can bid the 
highest price for it.! 

Paraphrasing a statement appearing in the Federal Reserve Bulletin 
for June, 1921,” what actually took place under the new arrangement 
was that the South African producers sent their gold to London, where 
they refined it to a purity of 999/1000. The gold was then sold at 
auction and was bid in by the agents of the producers, the price being 
determined on the basis of the dollar exchange rate with allowance 
made for commissions and expense of shipment. The gold was for- 
warded to New York where local agents of the producers sold it to 
the Federal Reserve Bank of New York through a member bank. 
Through this procedure it was possible for the South African producers 
to receive in New York $20.6718 for every ounce of pure gold, from 
which they had to deduct the cost of shipment from South Africa to 
New York via London and the commissions of the London and New 
York agents. If the bankers or gold using industries of England or the 
Continent required gold, it was necessary for them to bid above the 
price offered by the producers’ agents, which price, as noted, was fixed 
by the New York exchange rate on London. There have been almost 
no other bidders (excepting a few parties who from time to time have 
obtained small amounts for use in the arts), owing to the fact that no 
banker can afford to bid more for gold than its price at the dollar rate. 
In fact, the quotation on gold prevailing in the London market has 
been practically paralleled by our sterling exchange rate.* The Federal 
Reserve Bulletin stated that “A comparison of the two rates shows 
that frequently there is a slight margin of less than '%4 per cent be- 
tween the premium on the dollar and the premium on gold. This 
margin is sufficient to pay the costs of transportation, insurance and 
commissions from London to New York. These charges, not allowing 
for interest or commissions, are estimated at approximately two-tenths 
of one per cent.” * The sale of their gold in New York enables the 
South African producers to obtain American bank accounts (dollar 
exchange in New York), which they can easily dispose of, either in 
London, South Africa, or in any other exchange market. 


1Tt was for this reason that most of our gold exports during the Civil War went to Eng- 
land, while during the Napoleonic wars Hamburg secured the greater portion of England’s 
gold exports. 

2P. 681. 

*CEA D470: 

4 Federal Reserve Bulletin, June, 1921, p. 681. 


GOLD AND GOLD MOVEMENTS 381 


During the war, few questions were more frequently asked than 
why, in the face of war, of suspended gold payments, and of the very 
large increase in paper currencies, was no premium quoted on gold 
in the London market? Its absence during the war was due to the fact 
that the government completely controlled the market. Gold exports 
were prohibited, so there was no object in offering a premium for 
gold bullion, because the buyer could do nothing with it but sell it to 
the Mint or to the Bank of England, and neither would pay a premium.! 

It is not at all unusual for gold coins, instead of gold bars, to be 
shipped from one country to another. Gold coins are not accepted at 
their face value (by tale or by count) but at their actual weight. The 
Bank of England buys gold coins 9/10 fine in normal times at a rate 
of about 76s. 414d.” per ounce provided they are full weight. Coins 
are seldom full weight, so the Bank of England usually pays about 
76s. 314d. per ounce for coins 9/10 fine. The student of the exchanges 
should not conclude that when foreign gold coins flow into the Bank 
of England, the Bank immediately turns them into bullion or presents 
them at the Mint later to receive English coins in return. The Bank 
in normal times has acted (and in the future may possibly continue 
to act) as the world’s greatest keeper of gold upon which demands are 
likely to be made at any time for large quantities of the yellow metal 
in coins or in bullion. Rather than ask for bar gold those having pay- 
ments to make in France may demand French Napoleons, those having 
payments to make in the United States may demand eagles, etc., etc., 
so that the Bank usually stores away the bags or boxes of foreign coins 
which it receives and pays them out when they are demanded.* 

The easiest method by which foreign bankers obtain gold in England 
for export is to purchase bills of exchange in their home countries, send 
them to England for discount or payment demanding in return therefor 


1Commercial and Financial Chronicle, February 7, 1920, p. 510. 

2Or at the rate of $4.8719 per £1, which represents a slight discount. 

8For an excellent discussion of the regulations and practices of the central banks of 
England, France, and Germany and of the United States Mint in connection with specie 
shipments, see Whitaker, op. cit., Chapters 19 and 20. 

4It is interesting to note that during the war, bags of gold that came to the Bank of 
England from Sweden were found to be American eagles which had been sent by France 
to Germany at the end of the Franco-Prussian War, and sent by Germany to Sweden in 
return for supplies during the World War. Even the original bags were used in shipping 
the gold to England. On December 28, 1916, we received $33,000,000 in gold from the 
British Government’s depository at Ottawa. Over three-fourths of the shipment was in 
the form of American eagles, sent to us in the same boxes in which we had forwarded them 
to Paris in 1904 to pay the $40,000,000 claim of the old French Panama Canal Company 
for its equities in the Canal Zone. 


382 DOMESTIC AND FOREIGN EXCHANGE 


Bank of England notes, and then to present the notes to the Bank of 
England for sovereigns. The Bank of England is compelled by law 
to redeem its notes at par in sovereigns (but not in gold bars). The 
Bank had never interposed any objections or hindrances to doing so 
until the outbreak of the World War.’ The sovereigns, while not re- 
quired by law to be full weight, are within the limits placed by the 
tolerance of the Mint.” This results, however, in the exporter of gold 
receiving from 2/10 of 1 per cent to 25/100 of 1 per cent less gold than 
the par value of the bank notes, making the gold cost him approxi- 
mately 78s., instead of 77s. 1044d. In the foreign market, however, 
the sovereigns are accepted only by weight and not by tale, so that 
the English exporter or the foreign importer takes these facts into 
consideration when figuring on the possibility of the profitableness of 
a gold shipment. 

Foreign gold coins of bar gold, rather than sovereigns, may be de- 
sired for export. The Bank of England and the Royal Mint are not 
compelled to supply these forms of gold, nor are they by law required 
to charge a fixed price for either. The price in all cases varies with the 
market. In the fall of 1890, when gold was urgently needed in New 
York, the Bank refused to sell gold bars and, although willing to sell 
foreign coin, nevertheless charged what was considered the exorbitant 
price of 76s. 7d. to 76s. 8d. for it, which was at the rate of approxi- 
mately 78s. for gold 11/r12ths fine. 

The gold that is produced in our own country, and not used in the 
arts, may be disposed of to the United States Mint. Our government 
stands ready at any time to take gold in unlimited amounts * from 
producers or others at the fixed price of $20.67183 per ounce pure, or 
at $18.60465 per ounce 9/roths fine. The price which our Mint will 
pay for gold is fixed and does not vary from day to day as does the 
price of the Bank of England. The Mint pays go per cent of the esti- 
mated value of the metal upon deposit, and the remaining 1o per cent 
less a melting charge of 4¢ per $100 as soon as the exact value of the 
gold has been ascertained. In some cases this requires a wait of only a 
few hours. Until the spring of 1921, all of the gold imports crossing the 


1The Bank of Netherlands is the only bank in Europe besides the Bank of England 
where it has been possible in normal times to obtain gold for export without any serious 
obstacles being interposed. Its supply of gold, however, has never been large, so that 
heavy exports have inevitably led to the Bank’s raising its discount rate within a very 
short time after exports have begun. 

2 Sovereigns may be legal tender if not lighter than full weight by .77447 grains. 

8 Although the law does not compel the mints to take gold in smaller amounts than $100. 


GOLD AND GOLD MOVEMENTS 383 


Atlantic were handled by the New York Assay Office of the United 
States Mint. Its capacity was about $15,000,000 in gold a day, but 
owing to the tremendous influx of the precious metal in 1920, a large 
portion of the importations had to be sent to the Philadelphia Mint. 
The delay occasioned by the inability of the New York office to handle 
the gold resulted in a loss of thousands of dollars a day in interest to the 
shippers who were forced to hold the metal idle until it could be assayed 
and accepted by the Federal authorities. 

Shipments of gold and silver are made only by international bankers 
who have equipment and facilities for handling large transactions, 
although under unusual circumstances, gold may be shipped by large 
mercantile houses. It is said that ordinarily not more than nine or 
ten bankers in New York and a few on the Pacific Coast concern them- 
selves with gold shipments. 

From what has been said above and in previous chapters, it may be 
seen that there are two main movements in specie shipments, one from 
the mines or producers to the market, the other arising in connection 
with the apportionment of the world’s gold supply among the various 
countries through the settlement of trade balances or in order to take 
advantage of prevailing exchange rates. It is with the latter move- 
ment, depending as it does primarily upon fluctuations in exchange 
rates, that we are chiefly concerned in this chapter. 

As a rule the precious metals are shipped only when it is profitable 
to do so, although, as we shall see later, occasions arise which neces- 
sitate or induce such shipments even at a loss. Whether or not ship- 
ment will take place depends usually upon the position of the exchange 
rates. If the rate that is being charged for exchange on some foreign 
country is so high that it will be cheaper to send gold than to buy 
exchange, gold will be forwarded. If, on the other hand, the price 
that bankers are paying or charging for exchange makes it profitable © 
to import gold, gold will be shipped. The same general statement 
applies likewise to silver shipments. In the case of gold standard 
countries, the rates of exchange at which gold will flow into or out of a 
country are known as the “gold points,” or “specie points.” These 
points are fairly definitely fixed, but we shall see later that they are 
slightly variable. The gold export point is the par of exchange plus 
the cost of exporting gold, while the gold import point is the par of 
exchange minus the cost of importing gold. Thus while the par of 
exchange does not change unless either or both of the countries con- 


384 DOMESTIC AND FOREIGN EXCHANGE 


cerned change the gold content of their standard monetary unit, 
nevertheless the costs of actual shipment, or possibly the cost of the 
gold itself, may vary from time to time, with corresponding changes 
in the position of the gold points. 

Let us consider first the details of gold exportation as they concern 
the American banker in his relations with London. It is impossible 
in any volume to deal with other than typical cases. A knowledge 
of the fundamentals is sufficient for our purpose. 

As has been stated above, gold may be shipped as gold bars or as 
gold coins. We find both being resorted to at all times. When coins 
are shipped, no matter how securely they may be packed, there is 
bound to be a certain loss through abrasion. They are also much more 
difficult to handle. There is less wear and tear on gold bars, so that, 
if possible, bankers prefer to use them. The United States Treasury 
stands ready at any time to supply the exporter with gold bars as long 
as they last at a charge of 4¢ per $100, which covers the cost of assay- 
ing, melting, etc. It usually takes at least a day to obtain the gold, 
pack it, and place it on the outgoing steamer. If the sailing date is 
two or three days hence, the interest lost in that connection must be 
taken into consideration in calculating the costs. Also, if the bank 
accumulates the gold bars or the gold coins over a period of time so 
as to have them available for use when needed, and if such gold cannot 
be used by the bank in any other connection for the time being, the 
interest cost of this investment must likewise be counted as part of 
the total costs. 

The gold must be securely packed, usually in kegs holding $50,o0o— 
no more and no less—and carted to the wharves under the protection 
of guards. Wages and cost of material must be paid.1 The shipment 
has to be insured against loss. In normal times, the insurance rate is 
approximately 1/20 of one per cent of the value of the shipment. At 
the outbreak of the World War, it rose to one per cent because of the 
extra risks experienced by all shipping. In February, 1917, following 
the establishment of a barred zone by Germany, a flat rate of ro per 
cent on all shipments to ports within that barred zone became effective, 
although in some instances an insurance rate of eight and nine per 
cent was asked on shipments to the ports of the United Kingdom. 
Mediterranean quotations ranged from ten to twelve per cent at that 
time, but in December, 1916, they had gone as high as fifteen per cent. 


1 Approximately $60 to $70 per $1,000,000 of shipment. 


385 


GOLD AND GOLD MOVEMENTS 


OosIoUBIT UBS Jv PIATaIeI BuToq ‘VUIYD WoO UlOD pu UOT[NG pos Ut Coo‘ooo'rg Jo JuauIdTYS 
{poomzepuy 2p pooaspug Aq *sT6T “3421AdoD} 





386 DOMESTIC AND FOREIGN EXCHANGE 


As the danger passed, the rates gradually declined,’ until in May, 
1921, according to Mr. René Leon, Manager of the Bullion Depart- 
ment of the Guaranty Trust Company of New York, marine insur- 
ance was obtainable at 3/40 of one per cent. Ocean freight charges 
also have to be paid. In May, 1921, Mr. Leon estimated these 
charges at approximately 3/4 of one per cent of the value of the ship- 
ment. Freight charges vary considerably and since 1914 have been 
much higher than the figures given by writers before that date. 

If the gold is forwarded to London and no draft covering the value 
of the shipment is drawn and sold in New York, the exporter loses 
interest on the gold while it is in transit. If, on the other hand, he 
wishes to protect himself as much as possible against the loss of interest, 
he draws a draft against his foreign account, which he is increasing by 
the gold shipment, the draft usually being for the full amount of the 
shipment, and sells the draft to some New York banker who desires to 
obtain exchange on London. If the draft is sold on the day that the 
gold is shipped, the draft, if it is a sight draft, will arrive in London 
and be payable three days before the gold is ready to be deposited to 
the London account of the exporter. If asa result the account of the 
exporting banker is overdrawn, he will be put to the expense of an over- 
draft. The interest charged by the London bank will be at the Bank 
of England’s discount rate or at from % per cent to 1 per cent above 
it. Cables are seldom, if ever, sold against gold exports, because a 
cable would reach London and become payable from seven to ten days 
before the arrival of the gold. If the banker in New York, to whom the 
draft against the gold has been sold, pays the exporter in cash, the 
bank would still lose interest for the one day that was required to ob- 
tain the gold, pack it, and place it on the steamer. And if payment 
is made by draft or check, it will be collected through the clearing 
house and another day’s interest will be lost; if a holiday or Sunday 
intervenes, a third day’s loss would be borne by the exporter. If, when 
the gold reaches London, the correspondent is instructed by the ex- 
porter to sell it to another party,” the London purchaser will pay out 

1 Insurance rates per $100 on gold shipments in June, 1916, were as follows: From New 
York to Japan, across the continent, 1714¢; to Argentina, 20¢; to European ports, 15¢ 
and to Spain, 37%¢. New York Journal of Commerce and Commercial Bulletin, June 16, 
iat matters not whether the gold after its arrival is sold to another party in London or 
deposited to the account of the exporter; in either case, the London account of the exporter 


will be ultimately increased by the amount of the gold shipment and thus be capable of meet- 
ing the draft when presented for payment. 


GOLD AND GOLD MOVEMENTS 387 


but go per cent of the value of the gold while its weight and fineness 
are being determined, the remaining Io per cent being paid at the end 
of three days. This loss of interest on ro per cent of the value of 
the gold for the three intervening days must be counted in by the ex- 
porter. If the London correspondent is paid a commission for its part 
in the transaction (which is by no means the custom), it will normally 
amount to 1/40 of one per cent of the value of the shipment. Finally, 
the prevailing price for gold in the London market is a matter of im- 
portance. When the gold leaves New York, the price in London may 
be 77s. tod. for bar gold and 76s. 414d. for eagles. By the time the 
shipment reaches London, the price may have declined to the Bank 
of England’s minimum rates of 77s. 9d. and 76s. 314d. respectively. 
If the exporter’s expected profit has been calculated on the basis of 
the rates prevailing at the time of shipment (which in their turn are 
based on the mint par of $4.8665), he may find that the transaction 
will yield him a much smaller profit, no profit at all, or even a slight 
loss. The price of gold in the London market may fall at any time 
to the Bank of England’s minimum price, but it cannot go below it. 
The exporting banker, therefore, must always keep that fact in mind 
when figuring on the expected profits from a gold shipment. It is be- 
cause of that fact that many banks construct what they call a “prac- 
tical’’ par of exchange for use as the basis of their export calculations 
in preference to the mint par. In the case of sterling exchange, they 
figure that if an ounce (480 grains) of gold 11/12ths fine may possibly 
bring only 77s. 9d. of English money, it is necessary to send a little 
more than one ounce, i. e., 480.7717 grains, in order to be sure that 77s. 
10%d. of English money may be received. If 480 grains of gold 
11/r2ths fine equal 77s. 1014d., the mint par of exchange between 
England and the United States is $4.8665—but on the basis of the so- 
called “practical par” of 480.7717 grains of gold to 77s. 10!4d., the 
cost of £1 becomes $4.8744.1 

The cost of exporting gold varies in accordance with the items that 
make up the total charge.” If freight, insurance or interest rates de- 


1Samuel Montagu & Company, prominent English exchange and bullion dealers, con- 
struct their ‘practical’? pars of exchange on all countries in this manner. Gold parity 
between the pound ‘sterling and the franc is thus set at 25.207 francs instead of 25,2215 
francs; between the pound sterling and the mark at 20.418 marks instead of 20.428 marks, 
etc. Cf. any number of the Weekly Review of Foreign Exchanges issued by Samuel Montagu 
& Company of London. 

2 As typical of the changed conditions wrought by the World War, the Anmnalist of Jan- 


388 DOMESTIC AND FOREIGN EXCHANGE 


cline, or if the charges for packing, carting, etc., fall, the total costs 
will be smaller, and vice versa. One must also remember that the 
costs of the individual shipper will depend upon whether he is shipping 
a large or a small amount, his facilities for packing, whether he is send- 
ing bars or coins,' and whether or not the mint or banking authorities 
in the country to which he is shipping the gold accord him certain 
concessions, such as giving credit for interest on the gold before it 
arrives, etc., etc. The gold export point is therefore not only a variable 
over a period of time for all shippers, but it is also a variable as between 
different shippers.? During the last twenty years of the roth century, 
text-books gave the gold export point as 4.89 or 4.90 because of the 
higher costs of shipment. In the years immediately preceding the 
World War it was commonly stated that the cost was about 1144¢ or 
2¢ per pound sterling, so that the gold export point was quoted as being 
4.8815 or 4.8865, respectively. In May, 1921, Mr. R. Leon, of the 
Guaranty Trust Company, estimated the costs as then being approxi- 
mately 1.1 per cent of the value of the shipment, apportioned as follows: 


Ereighit, 3475. . ox gale eee 75 
Insurance, 349%. 4.9 ee (O75 
Interest, 15 days @ 6%.......... 38 
incidentals, 44%. 6. ee 025 
1.100 


On this basis the cost of exporting a sovereign would be $.0535315, 
and the gold export point would be 4.92. Whether or not gold will 
be exported depends normally on the position of the sight rate of ex- 
change. If the sight rate is higher than the gold export point, gold 
will, as a rule, flow out of the country; sometimes, indeed, it flows 
out before the exchange rate warrants its going. It will usually be 
exported because it is cheaper or more profitable to ship gold than 
to purchase exchange at a greater cost. The position of the cable 


uary 24, 1916, gives the following table illustrative of the costs of shipping $10,000 in gold 
to Amsterdam in that year, and also before the war. 


Current Cost Ante-Bellum Cost 
Insurance (7/8 Vo ae wee $87.50 (1/20 of 1%) $5.00 , 
Freight (3/49) oe eee eee 75.00 (1/4 of 1%) 25.00 
Miscellaneous (1/89)... 2400605 ese eak 12.50 (1/8 of 1%) 12.50 
$175.00 . $45.50 


1 Shipments of coin are the more costly. 

2 For additional details regarding specie shipments, see Whitaker, op. cit., Chapter XX; 
Patterson, op. cit., Chapter 13; Johnson, J. F., “Money and Currency,” (1921 ed.), pp. 9o- 
g1; Margraff, op. cit., Chapter 27. 


/ GOLD AND GOLD MOVEMENTS 389 


rate of the long bill rate has nothing whatsoever to do with the gold 
export point. This statement, as will be noted later, cannot be said 
to be wholly true in the case of gold imports. 

The following example of an instance of gold export is taken from 
data supplied by Escher: ? 

Suppose that an American banker desires to export 10,000 ounces 
of bar gold, 993/100o fine. He purchases that amount from the 
United States Mint at its fixed price of $20.6718325 per ounce fine, 
or for $205,271.29. He must also pay the premium of 4/100 per cent 
charged by the United States Assay Office for bar gold, or $82.08 for 
the amount of bar gold purchased. Packing, cartage, etc., of five 
kegs at $2.25 per keg, costs him $11.25. Freight at 5/32 per cent costs 
him $320.75, and insurance at 1/20 per cent less ro per cent, comes 
to $92.34. The total cost of buying and shipping the gold is $205,- 
777.71. When the gold reaches London, say that it is purchased at the 
Bank’s minimum rate of 77s. od. per ounce 11/r12ths fine. The ex- 
porter receives the sum of £42,112 10s. In addition to the 1/40 per 
cent commission to his correspondent, or £10 tos., he has to pay cer- 
tain petty charges amounting to £1 18s., both of which sums are de- 
ducted from the amount he receives for his gold in England. The net 
proceeds credited to his account are £42,100 2s. In order not to lose 
on the shipment, it will be necessary for him to sell sterling sight drafts 
at 4.8878. If he is able to sell sight drafts at a figure above that sum, 
he obtains a profit on the shipment. 

Gold imports usually, though not always, occur when it is profitable 
to undertake them. If exchange rates in the United States fall so low 
that it is profitable for bankers to purchase exchange, send it abroad, 
cash it in, and bring the gold back to the United States, gold imports 
will normally take place. Or if a large importer has become very dis- 
couraged with the prevailing low rate of exchange and prefers to send 
his drafts to England to be paid and the returns forwarded to him in 
gold, gold will flow into our country. This latter situation will seldom 
occur, however, because it is only the big international bankers who 
engage in gold shipments. 

To pay for the gold which is to be imported, the banker may pur- 
chase long bills, say, on England, send them over for acceptance and 
discount, and advise his correspondent to return the proceeds in gold. 
Or he can purchase sight exchange or cables and forward them to Eng- 

1 Escher and Jefferson, op. cit., p. 377. 


390 DOMESTIC AND FOREIGN EXCHANGE 


land with the order that the proceeds be returned to him in gold. Or 
by cable or sight draft he can cash in on the account which he already 
has in London, and ask that the gold be sent him. No matter which 
method is followed, he must consider the rate charged for cables or for 
sight drafts. The position of one or the other will necessarily affect 
the position of his gold import point. If he uses cables with which to 
purchase gold in England, his import point will be a little higher than 
if he uses sight exchange. Sometimes the spread between the two 
rates is so slight as to bring the import point of gold when based on 
the cable rate very close to the import point when based on the sight 
rate. The cable rate is therefore one of the essential elements that go 
to determine whether or not gold will be imported. 

The costs of importing gold are greater than the costs of exporting 
gold, for the reason that the loss of interest on the inward shipment 
must be taken into consideration. If the New York importing banker 
purchases a demand draft, say on England, and forwards it to his 
English correspondent with directions that gold be returned to him, 
he will have to bear the loss of interest on the amount of his invest- 
ment until the draft reaches London, is cashed, and the gold returned 
to him, approximately twenty days. On the other hand, if he pur- 
chases a cable (it takes but a few hours for the cable to reach London), 
he will have to bear the loss of interest on the money invested only 
for the length of time required to have the gold arrive from London, 
which would be approximately ten days, but he will have to pay a 
higher rate for the cable than for the sight draft. With gold exports 
it is possible for the banker to draw a draft against the gold as soon as 
shipped, thus enabling him to minimize or to obviate entirely the 
loss of interest. But drafts cannot be drawn against gold imports, 
and the only way by which loss of interest can be offset is by the cen- 
tral bank or the mint in the importer’s country according credit or 
paying interest for gold imports while in transit. This will be more 
fully discussed in a latter part of this chapter. 

As in the case of gold exports, so with gold imports there are a large 
number of variables that must be taken into account, so that it is not 
possible to say that the gold import point is exactly or permanently 
fixed, either for an individual shipper or for shippers as a whole. In 
the first place, there is the rate that the importer will have to pay for 
exchange on London; whether it be drafts or cables, with which he 
pays for his gold, and these rates are continually fluctuating. Next, 


GOLD AND GOLD MOVEMENTS 301 


there is the varying cost of gold itself in the London market. As noted 
above, the price of gold is not fixed in London, and although it can 
never fall below the minimum price of the Bank of England for gold 
coins or gold bars, it may rise considerably above that figure even in 
normal times. In the third place, there is the question as to the pos- 
sibility of obtaining gold bars or of being compelled to take gold coins. 
Interest charges, freight, insurance, and costs of packing and cartage, 
are all variable items of expense. When the gold reaches the United 
States it can be sold to the United States Mint at the fixed price of 
$20.67183 for pure gold, or $18.60465 for gold o/roths fine. If gold 
coins are imported, another variable, that of abrasion, must be taken 
into consideration. ‘There is, moreover, a slight delay at the mint, 
because the gold has to be assayed and weighed. The result of all 
the varying costs is that authors and bankers give out differing state- 
ments as to the gold import point for the United States. Some claim 
that as a rule costs approximate 2 cents, while others claim that they 
run as high as 214 cents per pound sterling. The gold import point 
would accordingly be respectively 4.8465 or 4.8415. It is again well to 
advise the student of the exchanges that the gold points are only ap- 
proximations and vary with each separate transaction depending upon 
the conditions existing in the market, the way the deal is handled, the 
amount shipped, etc., etc. | 

The data for the following example of an importation of gold from 
London are based upon an instance cited by Patterson. On Septem- 
ber I, 1915, 5,282.157 ounces of standard gold were purchased in Lon- 
don at the rate of 77s. 11d. per ounce, costing in all £20,578 8s. 1d. 
The gold was received in New York on September to, 1915, and im- 
mediately turned over to the United States Assay Office, which paid 
go per cent of its value on delivery, or $89,000. Four days later it 
paid the remaining to per cent ($11,097.18), the importer receiving 
a total of $100,097.18 for the shipment. From this sum he had to de- 
duct certain charges. Freight and insurance cost him $1,389.94; assay 
charges, $15.59; interest at 314 per cent on go per cent of the shipment 
during the nine days that it was in transit, $77; interest at 314 per 
cent on the remaining $11,097.18 for four additional days (13 days in 
all), $13.81; making a total cost of $1,496.34. The cable rate on Lon- 
don on September 1 was $4.56 per pound. In using cables to purchase 
£20,578 8s. 1d. in London, the importer had expended $93,837.62; 

10D. cit.; p. 183. 


392 DOMESTIC AND FOREIGN EXCHANGE 


import costs had amounted to $1,496.34; leaving net profits of 
$4,763.22. The profits would have been greater or less depending 
upon the fluctuations in the costs of shipment, the rate paid for the 
cable or sight draft with which the gold was purchased, the cost of 
the gold in England, whether coins or bars were shipped, etc. 

For a number of years before the World War, the London Economist 
quoted the gold points on the United States as follows: 


Dollars 4.89 —5 per mille for us (meaning for England) 
**  4.867—par. 


¢ 4.827—8 per mille against us (meaning against England) 


The 5 per mille (5/10 of one per cent or .oo5 per cent) covered 
freight, packing, etc., on gold sent to England from the United States, 
while the 8 per mille (8/10 of one per cent) represented the costs when 
gold was sent from England to the United States. The reason why it 
cost the London bank more to export than to import gold was because 
there was little or no demand for bills in London on New York, making 
it necessary for the bank to wait for a return remittance from New 
York, thereby sustaining a loss of interest. This lack of demand 
in London for drafts on New York was due to our long prevailing 
policy of remitting to London when we owed London, and of drawing 
on London when London owed us, the result being that all bills went 
to London and few, if any, bills came from London to the United 
States. 

As between the United States, England, France, and Germany, 
the gold points are normally quoted as follows: 


Import Export 
New York on London........ $ 4.825 $ 4.885 
SG SS Pais oh anne, oe ee . 19120 .19379 
. Ho. . Detling pees cre 23625 . 240625 
London*on Paris: 2) .caeee ee 25.325 francs 25.1225 francs 
* Berlin... hae: ae 20.52 marks 20.33 marks 


It should be noted that gold points for London on Paris and for Lon- 
don on Berlin are quoted on the basis of movable or indirect exchange, 
and that the points for New York are quoted on the basis of direct 
exchange. Gonzales gives the following data relative to the highest 
export and the lowest import gold points for the United States on 
various foreign countries: 4 

10p. cit., p. 86. 


GOLD AND GOLD MOVEMENTS 393 


Country Import Export 
CA Gh aoe eae oan De ate $4.82 $4.9065 
eM Rear ha) oak Kaci tie te alte Ms .19 .1940 
SIMREAEN ATIC 00h S45 ive ceca ao aa .19 . 1940 
[SES YS ee OEE yy Ea .19 .1940 
RS ea Toke 0 ha Ph OA | .19 . 1940 
ROLE: 2: sn aan ae, . 2350 .2410 
BEETS yar cs... dhs Tee ee a. .1850 . 1960 
Sy ELT tes A Si ee ep .1850 .1950 
TG He 2 ge OR 2 7p ee .9950 1.0050 
Herrero nM ty ee .4850 EeO2s 
Norway, Sweden and Denmark... 26 E2750 
PAY CEI Eye: 2 \'. Sake ia eee .4150 .4350 
Lear A Lie 1 A ERR ES a Sate Perey .3150 eaa50 
Clic ates tay ws. od 50a ee . 3180 . 3380 
Philippine Islands’ «scqesswasen .49 ae 


Gold shipments are at times sent from one country to another at 
the request of a banker in a third country. It is not at all unusual for 
American bankers to ship gold to South America or to the Orient at 
the order of and for the account of English banking firms because it 
may be more profitable or convenient to have the gold sent in that 
manner. During the fall of 1914, American bankers made payments 
in London by shipping gold to Ottawa, Canada, for the account of the 
Bank of England.! 

Gold is sometimes shipped to a financial center for the purpose of 
using it there to purchase exchange on a third center. Suppose that 
the exchange rate between Paris and London is low, between New 
York and London high, and that a New York banker figures that a 
profit can be made by sending gold to Paris and ordering his corre- 
spondent to purchase exchange on London, thus building up his Lon- 
don account against which to sell sterling sight drafts. The details of 
such a transaction based upon data furnished by Escher ? are as fol- 
lows: The exporter secures 48,500 ounces of bar gold .995 fine in New 
York at $20.5684 per ounce, costing him $997,567. He is compelled 
to add the assay charge of 4 cents per $100, or $400; freight of 1/8 per 
cent of the value of the shipment, or $1,247; insurance at 414 cents per 
$100, or $450; cartage and packing, $60; a commission to his corre- 
spondent in Paris of $250, and interest at the prevailing call rate in 


ECL. 531. 2 Escher and Jefferson, op. cit., p. 378. 


394 DOMESTIC AND FOREIGN EXCHANGE 


New York of 2 per cent for six days while the gold is in transit, amount- 
ing to $333. The cost of the gold plus the charges would amount to a 
total of $1,000,307. When the gold reaches Paris the Bank of France 
purchases it from the correspondent, say at the rate of 106.3705 francs 
per ounce, netting 5,158,969 francs. If exchange on London is at 
25.10 francs per pound sterling, 5,158,969 francs will buy £205,536. 
The correspondent will forward this exchange to the New York 
banker’s designated London correspondent and the New York banker 
will then be able to sell sight or cable exchange against the account 
thus built up. It may be that he has drawn his draft against the ship- 
ment of gold some days before the exchange from Paris reaches London, 
in which event his draft would be presented for payment before he 
has been credited with the amount in question, and he will have to pay 
interest on the overdraft. But if he calculates his time correctly and 
sells sterling exchange so that it reaches London after the remittance 
from Paris has reached London, there will be no overdraft. If he sells 
sight sterling at 4.8670, his shipment and exchange transactions will 
yield £205,536 worth of drafts, for which he gets $1,000,342. The 
shipment cost him a total of $1,000,307; he receives from the trans- 
action $1,000,342 or a profit of $35 on a shipment of 48,500 ounces 
of bar gold. If the costs of shipping were lower, if the rate of exchange 
in New York on London were higher, if the exchange rate in Paris on 
London were more satisfactory, or if the money rate in New York were 
lower than 2 per cent, the New York exporter would make a greater 
profit on the transaction; and of course the reverse would be true if the 
costs were higher or the exchange rates less satisfactory. 

Bankers export or import gold when there appears to be a reasonable 
opportunity of making at least 1/32 of one per cent, but gold shipments 
are frequently made at a loss. The best that can be said is that the 
profits from gold shipments are usually small. If from $500 to $1,000 
is cleared on an import or export of $1,000,000 the banker feels that 
he has been fairly successful in the venture. 

The student of the exchanges, however, should not conclude that 
gold always flows into or out of a country when the exchange rates 
are above or below the customarily accepted gold points. England has 
frequently experienced the failure of the gold points to work as they 
should in accordance with the principles laid down by the theory of 
the exchanges. It is not at all unusual for her to lose gold long before 
the exchange rates are sufficiently against her to justify its outward 


GOLD AND GOLD MOVEMENTS 395 


shipment; she may even lose gold when the exchange rates are in her 
favor. On the other hand, it has also been her experience that gold 
does not necessarily flow toward her when exchange rates should in- 
duce it.' Our own experience also justifies the statement that the 
customary gold points are not infallible indicators of a forthcoming 
export or import of gold. The many reasons why this is true will be 
pointed out in subsequent pages. 

During a panic or financial stringency when New York bankers are 
greatly in need of funds, they get cash in hand by selling exchange on 
their foreign accounts. This tends to lower the rate on those centers 
and it may fall below the import point without the bankers engaging 
gold for import. Their need is for immediate cash, and if gold is im- 
ported it will be from seven to ten days before it can possibly reach 
New York and relieve the stringency. Banks that are unwilling to 
wait for that length of time sell exchange at a rate lower than the gold 
import point. Gold may also be imported at times at an apparent— 
and sometimes at a real—loss. Interests that desire to influence the 
stock market favorably may import gold. Its importation affords the 
bankers a larger amount of credit for loans in the stock market, and 
tends to cause a falling off in the money rate. With the announcement 
that gold has been engaged for import or that it ‘is on its way, those 
who are manipulating the market buy large blocks of securities on a 
margin and hold them until the gold arrives and the money rates drop. 
This fall in the money rates induces freer buying, securities rise, and 
the speculating gold importers unload their holdings at a profit. 

Banks may import gold when exchange rates are still too high to 
warrant its coming, and to the outsider it might appear that a loss 
must be inevitably sustained. Investigation, however, may disclose 
the fact that money rates at home are very high and appear likely to 
remain so. The bankers may have felt that they can afford to take an 
apparent loss for the purpose of being able to get the gold, build up 
their credit, and expand their loans at the high rates of interest, thus 
more than recouping their loss on the gold shipments. A dollar’s worth 
of gold may serve as the basis for three and a half or four times that 
amount of loans. One must not overlook the fact, however, that the 
importation of gold and the extension of credit may in their turn bring 


1“Not only do we [England] always lose gold when the exchanges go against us, and 
often get none when they go in our favor, but we often lose gold long before the exchanges 
are sufficiently against us to justify its going, and sometimes even when they are strongly 
in our favor.’ Withers, “Money Changing,” p. 163. 


396 DOMESTIC AND FOREIGN EXCHANGE 


about a lowering of the money rate in the market and turn the venture 
into a real loss. 

Bankers and investment houses sometimes import gold at a slight 
loss for the advertising that it gives them. If the public learns that the 
banking firm of X. Y. Z. & Co. has received $1,000,000 in gold from 
abroad, it is apt to have a little more confidence in that house and 
possibly shift some accounts to it. Sometimes it is necessary for a 
bank to import gold even at a loss for the purpose of strengthening its 
position. German banks before the World War were accustomed, 
at certain periods of the year, to import gold even though exchange 
rates did not justify it, so as to meet the great demand for money. In 
October, 1916, a large amount of gold was taken from New York by 
the Canadian banks when exchange rates did not warrant it. The 
only explanation offered was that the latter were preparing to make a 
fine financial showing (‘‘window-dressing”’) preparatory to the pub- 
lication of their November statement of condition. 

In times of financial stringency it is not unheard of for the central 
banks of European countries or for our Treasury Department to give 
credit to the importer for gold that is in transit. Before the World 
War the Reichsbank of Germany frequently gave the importer credit 
for the gold as soon as it had left London or when it had reached the 
border of the country. When such aid is given, the importer can en- 
gage gold for shipment long before the exchange rate falls to the gold 
import point, his apparent loss being offset by the assistance given by 
the central bank or the Treasury Department. At one time during 
the panic of 1907-08, the Reichsbank gave interest to the consignees 
of gold while the shipment was in progress and also for three weeks 
additional. Gold shipments to the United States have been assisted 
at various times by the Secretary of the Treasury for the purpose of 
relieving banks of serious financial strain. In April and June, 1906, 
the Secretary of the Treasury aided the importation of gold by de- 
positing governmental funds with seven New York banks, thus giving 
them the use of government money while the gold was in transit. 
$50,870,000 worth of gold was imported at that time. Two of the 
banks made a slight profit of $1,000, three broke even, and two sus- 
tained a loss.’ Again on September 5, 1906, the Secretary of the 
Treasury deposited government funds with banks that were importing 
gold. Asa consequence of the aid given, the drain of gold from Europe 


1 Commercial and Financial Chronicle, July 14, 1906, p. 61. 


GOLD AND GOLD MOVEMENTS 397 


to the United States reached large proportions and deranged the Eu- 
ropean money market. The Reichsbank of Germany was forced to 
raise its discount rate on October 10, from five to six per cent while 
on October 11, the Bank of England raised its discount rate from four 
to five per cent and on October 19 to six percent. Finally, on Octo- 
ber 23, the Secretary of the Treasury announced the termination of 
the assistance. Approximately $54,000,000 worth of gold had been im- 
ported in that very short time; during the year the gold import had 
amounted to $103,000,000. 

In the early months of 1913, both Germany and France were in the 
American market for large amounts of gold. In January, 1913, $10,- 
000,000 of gold was shipped to France, although the exchange rates 
did not warrant it. In February, another $10,000,000 was sent to 
Argentina on Paris account, while Paris itself took $1,000,000. At 
this latter date, exchange rates began more nearly to approximate 
the gold export point. In March, $17,000,000 went to Paris, Berlin, 
Brussels, Venezuela, and Argentina, but all of the shipments to Europe 
were considered to be transactions involving a loss to the importing 
country. Shipments to France continued in May even though ex- 
change rates had declined—about $12,000,000 being exported at that 
time. Several reasons were advanced for these unexpected shipments. 
The Balkan War had caused a renewal of the fear of war with Ger- 
many. French peasants had begun hoarding gold in large quantities 
causing a drain on the gold reserve of the Bank of France, which re- 
sulted in a bad showing for several weeks in the latter’s bank state- 
ment. Gold had to be imported, even though not warranted by the 
exchanges. Gold was also commanding a premium in France, and the 
Bank of France could well afford to aid the importation by paying 
interest while it was in transit. The May importations were made 
partly because the Bank desired to be prepared to take care of the 
expected demand for loans by the home government and the Baikan 
States. 

The existence of a premium on money (for ready cash) may likewise 
cause gold to flow in spite of the position of the exchanges. An out- 
standing instance of this sort in our financial history occurred during 
the panic of 1907-08. Because of the monetary stringency in the fall 
of 1907, banks throughout the country were paying a premium of about 
3 per cent for gold, silver, or paper money in order to get funds with 
which to meet their local needs. This premium (3 cents on the dollar) 


3908 DOMESTIC AND FOREIGN EXCHANGE 


was equivalent to about 14 cents on the pound sterling ($4.8665). On 
October 26, sight sterling stood at 4.824 @ 4.825. During that week 
$19,750,000 of gold was obtained in London for shipment to the 
United States. The Bank of England on November 1 raised its dis- 
count rate to 514 per cent, on November 4 to 6 per cent, and on Novem- 
ber 8 to 7 per cent, and raised its price on bar gold to 78s. 1/8d. The 
Reichsbank of Germany raised its rate from 514 per cent to 6!4 per 
cent on October 29, and to 714 per cent on November 8. The obstruc- 
tions placed in the way of gold shipments through higher discount rates 
and the premium on gold charged by the Bank of England did not pre- 
vent the shipment of the metal to the United States. In October, sight 
sterling ranged from 4.8240 @ 4.8250 for low, to 4.8635 @ 4.8650 for 
high; in November from 4.85 @ 4.8525 for low, to 4.8850 @ 4.8875 
for high; and in December from 4.8410 @ 4.8415 for low, to 4.8660 @ 
4.8670 for high. It is evident that exchange rates played a minor 
part in gold imports, since they were for the most part consistently 
above the customary gold import point and at times approximated 
the customary gold export point. The controlling factor in the 
situation was the high premium on ready cash dominating the New 
York market. Gold importations were unusually profitable notwith- 
standing the loss of interest on imports resulting from the high rate 
on money with which cables were purchased (call money rates on the 
bulk of the business ranged from 20 to 50 per cent) and the premium 
on gold charged by the Bank of England. Inasmuch as cables were 
largely employed to pay for the gold, the banks followed the policy of 
counting the gold in transit as part of their reserves, thus making 
credit based on the gold available for loans in the New York market. 
During the first week of November, the gold engaged for import from 
the Bank of England reached approximately $44,000,000. The Bank 
of France, fearing that if it did not come to the assistance of the Bank 
of England the latter would be compelled to raise its discount rate 
to 7 per cent and thus seriously interfere with the Paris market, de- 
cided in October to buy 58,870,726.77 francs of English bills and to 
pay for them in gold. It subsequently purchased additional amounts 
and on November 5 forwarded to the Bank of England 80,000,000 
francs in American gold eagles, thereby relieving the pressure on the 
English market. Our government had attempted to induce the Bank 
of France to ship the gold directly to us, but we could not or would 
1On November 4, 1907, the sight sterling rate was 4.885 @ 4.8875. 


GOLD AND GOLD MOVEMENTS 390) 


not give the guarantees demanded, so the gold went to England 
and from there was forwarded to us. During October, November, 
and December, over $112,000,000 gold actually arrived in the United 
States, chiefly from London. 

The price paid for gold by the Bank of England and the price 
charged for gold in the United States may at times work to prevent 
gold movements when exchange rates justify them. This is illustrated 
by an instance that occurred in the spring of 1896. During the week 
ending April 3, 1896, the sight rate on England stood at 4.89% @ 
4.90, yet no gold was engaged for export. The price at which gold 
was selling in England was 77s. od., which, as we have seen, is the 
minimum rate at which the Bank of England purchases the precious 
metal. On March 25, the United States Treasury, in order to protect 
its gold holdings, had advanced its premium on gold bars from 1/16 
to 3/16 of one per cent, so that with the low price of gold in England 
and with the high premium being charged for gold bars in the United 
States the sight rate of 4.8914 @ 4.90 was not sufficient to induce 
us to send gold to England. 

Difficulties in negotiating exchange transactions on outlying coun- 
tries may also make it possible for the rates to remain for some time 
either above or below the gold points without gold shipments taking 
place. A supply of exchange on some outlying point may be available 
for which there is no demand, or there may be a demand for exchange 
on that point with no supply in sight. It is often difficult to negotiate 
bills on certain South American countries. The bills may be taken 
by the bank only as an investment, or the risk may be greater than in 
the case of ordinary bills, with the result that the rate that the bank 
will pay for the bills will be below the gold import point. Or it may be 
that an unusual demand may arise for exchange on some out of the way 
place, so that the exchange rate may rise and remain for some time 
above the gold export point without any gold being shipped. We also 
find that the rates charged or paid by small banks in dealing with their 
local customers are frequently above or below the respective gold 
points. Small banks charge or give “what the traffic will bear”’ with- 
out regard to gold points. In fact, many bankers who retail exchange 
of various sorts would be nonplussed if asked to explain the meaning 
and importance of “gold points.” 

While one might expect that, with the exception of war periods, 


10On May 29, 1896, the premium on gold bars was reduced to 1/8 of one per cent. 


400 DOMESTIC AND FOREIGN EXCHANGE 


the exportation of gold could be no more interfered with than the 
exportation of any other commodity, nevertheless we do find obstacles 
of various kinds being put in the way of its movement. Gold is the 
one commodity of all commodities that a nation as a rule is hesitant 
about exporting to too great an extent. Gold imports are much pre- 
ferred and are anticipated with a great deal of optimism, although it 
remained for the World War, that destroyer of many ideals, “laws,” 
and theories, to give us the strange phenomenon of nations protesting 
against receiving too much gold from their debtors and even taking 
steps to prevent its importation.! In times of war, gold movements 
are usually under the complete regulation and control of the govern- 
ment, or are absolutely prohibited. But even in normal times it is con- 
sidered advisable that some means be provided whereby the gold sup- 
ply of a country, and incidentally the import and export of gold, can 
be rather closely controlled, regardless of the exact position of the ex- 
change rates. The central banks of Europe and the Federal Reserve 
banks of the United States are the custodians of the gold reserves 
of their respective countries. Up to the time of the enactment of the 
Federal Reserve Law, there was no possibility of regulating our gold 
flow in any manner whatsoever except through the action of the 
Treasury in granting credit for gold in transit, or through the govern- 
ment’s contracting with a syndicate to control gold exports, as was 
done during the panic of 1893. Gold flowed into or out of our country 
in untold millions, yet we had no more control over its coming or going 
than over the waves of the ocean, and only in the most extraordinary 
situations, when the interests of the government itself were at stake, 
did we move to erect a dam to obstruct, or to dig a channel to guide, 
its flow. During the panic of 1893, Europeans dumped securities on 
our markets in such quantities as to crush our stock exchanges and to 
cause a tremendous outflow of gold,” crippling our banks and bringing 
our government to the verge of bankruptcy. Linked with these de- 
velopments were the workings of the so-called “endless chain” ® 
and the drain upon our gold resources caused by our very heavy ad- 
verse balance of trade, both of which were active factors in depleting 
our gold holdings and in almost wrecking our financial system. In 

1Cf. pp. 424-425. 

2 During the first six months of 1893 we exported approximately $62,000,000 in gold. 

3 Gold was drawn from the United States Treasury by the use of greenbacks and 


Treasury notes, which, when paid out again by the government according to legal re- 
quirements, were gathered up and presented to the Treasury to be redeemed in gold. 


GOLD AND GOLD MOVEMENTS 401 


its necessity, the government finally made arrangements with the 
“Morgan-Belmont” syndicate to protect its interests. The syndicate, 
in order to bring exchange rates below the gold export point, pursued 
the same tactics in pegging the rate that were adopted by England 
during the war. It sold large amounts of securities to European in- 
vestors and drew drafts against such sales, thus increasing the supply 
of exchange and reducing the sight rate below the export point. In the 
early part of May, 1895, the exchange market was flooded by large 
offerings of such drafts. Sterling sight rates fell from 4.90 @ 4.90% 
to 4.8714 @ 4.88. The syndicate also sold large amounts of exchange 
on the bank accounts of its members in European countries, and as 
the rates eased off it was able to recoup itself and buy cover at rather 
favorable rates. During June, 1895, issues of Illinois Central bonds, 
Alleghany Valley Railway bonds, and City of Chicago loans were 
negotiated abroad, but they fell short of supplying the demand for ex- 
change, rates again rose, and the syndicate was forced to enter the 
market and supply the necessary exchange to take care of the situation. 
A month later sight sterling rose to 4.9014 with cables at 4.90 3/4, and 
the syndicate once more found itself obliged to meet the heavy demand 
for drafts. About $2,000,000 of gold was exported at this time. In 
August, with cables at 4.91, about $15,000,000 gold was exported. 
Finally in September, a shipment of $14,150,000 gold succeeded in 
breaking the market with the result that the rates eased off very satis- 
factorily. Also, at this time cotton future bills came forward and 
helped to create an adequate supply of exchange. Developments 
during the panics of 1907-08 and 1914 again revealed our absolute 
lack of control over the movement of gold. It was partly to remedy 
this condition of affairs that the Federal Reserve Law was passed in 
1913, creating an open discount market and permitting the manipu- 
lation of the discount rate by the Federal Reserve banks for the pur- 
pose of controlling gold movements. As yet (1922) however, we have 
had no occasion to try out the new machinery devised to meet 
such emergencies. It is confidently expected, however, that it will 
work successfully when called into play, for it is a replica of the method 
followed by most of the central banks of Europe. 

Until conditions in the financial world were upset by the declaration 
of war in 1914, the Bank of England had stood for centuries as the 
world’s greatest warehouse of gold,’ receiving and giving out gold in 

1 The following table shows the gold holdings of the Bank of France, the Reichsbank, 


402 DOMESTIC AND FOREIGN EXCHANGE 


a lavish manner according to the requirements of trade, finance, or the 
foreign governments. It has not held the largest amount of the yellow 
metal (the Bank of France and, before the Great War, the Reichsbank 
and the Bank of Russia usually holding much larger sums), but it has 
really been the world’s greatest warehouse because of the enormous 
sums of gold that have continually flowed through its vaults. The 
“Old Lady of Threadneedle Street,” however, is wise enough, and 
possesses adequate means, to safeguard her hoard if the occasion de- 
mands it. To do so she has recourse to any of a number of different 
expedients. Usually her reserves against deposit liabilities range from 
30 per cent to 50 per cent, averaging about 43 per cent. If asa result 
of the gold drain the Bank’s reserves get dangerously low, or if a heavy 
gold export movement occurs which the Bank feels ought to be pre- 
vented or hindered, or if for some reason gold imports should be en- 
couraged, the Bank may become the dominating and guiding factor 
in the situation. It may go into the market and bid high in order to 
obtain the needed supply of new gold; or, to hinder gold being taken 
for export, it may charge a higher price than customary for foreign 
gold coins, or it may refuse absolutely to sell gold bars.! 

The Bank may find, however, that the gold is being drawn away 
more rapidly than it can be accumulated, or that other parties in the 
market are willing to bid higher for the new gold. The Bank can then 
resort to a change in the minimum rate at which it will discount three 
months’ bills. Through its discount rate it may manipulate the gold 
movement without entering the market asa higher bidder. Raising the 
discount rate acts in several ways to influence the market and to assist 
the Bank in controlling the flow of gold. In the first place, a rise in 
the Bank’s discount rate is usually followed by an increase in the money 
rates of other banks and discount houses in London. If, in normal 
times, the market money rates do not rise, the Bank may refuse to 
loan money to bill brokers or to stock and bond dealers. This refusal 


and the Bank of England at the time of their last weekly reports for December of 1913 
and March, 1922. The data have been reduced to pounds sterling for comparison: 


Last Weekly Report December, 1013 March, 1922 
Pra titeys 65 225. oor oe eacenerneenane 5 £140,696,000 £221,033,007 
Serinany 256. fete yeas: 77,793,000 49,819,250 
Englands. ii. cave sawn eee 34,083,149 128,770,763 


On March 22, 1922, the Federal Reserve banks held $2,976,703,000 in gold and gold cer- 
tificates. Converting the same at the rate of 4.86 per pound sterling for comparison witb 
the holdings of the European banks, gives the figure of £612,490,333. 

1 As it did in 1890. 


GOLD AND GOLD MOVEMENTS 403 


compels them to go to the joint stock banks for their loans, and nor- 
mally results in raising the market rates. When the Bank of England 
decreases the amount of loanable funds in the market the joint stock 
banks may have to call in their loans from brokers and others, com- 
pelling the latter to go to the Bank of England for funds. The Bank 
may then charge what rates it deems necessary to force the money 
rate in the open market to the desired level. When money rates are 
high in England, owing to the increased discount rate of the Bank of 
England, foreign bankers hasten to transfer their funds to England 
so as to earn the higher interest rate. Prices of securities usually fluc- 
tuate inversely to money rates. As money rates rise, the London 
prices of securities fall, and it becomes more profitable for foreigners 
to buy securities in London than at home. A demand is thus created 
for sight and cable exchange on London, which in the end tends to 
raise the sight rate in foreign countries to the gold export point and 
soon gold begins to flow toward England. Proceeding from another 
angle, the same object is accomplished. High money rates prevailing 
in England induce the English and foreign 'bankers to keep their funds 
at home in preference to exporting them to other countries. London 
bankers and others, who have funds invested abroad, recall them to 
England. Raising the discount rate therefore not only induces gold 
to flow toward England, but at the same time hinders its flow out 
of England. It also makes it more difficult to finance home industry 
because of the higher money rates. It causes goods, held for specu- 
lative purposes (mostly on borrowed money), to be thrown onto the 
market. Industry slows up; prices fall; it becomes cheaper to buy in 
England. This creates a demand for exchange on England with which 
to pay for goods purchased, and sterling exchange tends to rise in 
foreign centers to the gold export point. 

The higher discount rate in England enables American bankers to 
pay less for long time bills because more will be deducted from their 
face value when they are discounted in England. Where ordinarily 
the banker will purchase long bills with the idea of discounting them 
in London in order thus to build up his account and make it possible 
to sell sight exchange against that account, he will find it more profit- 
able, when the discount rate is high, to purchase long bills for invest- 
ment and to hold them until maturity. This does not increase his 
foreign account and consequently does not create a supply of ex- 
change available for sight drafts. Thus, by raising the discount rate, 


404 DOMESTIC AND FOREIGN EXCHANGE 


the Bank of England creates a demand for sight exchange on the part 
of those who wish to transfer funds to England wherewith to take ad- 
vantage of the higher money rates, and at the same time it effectively 
limits, for the time being at least, the amount of sight exchange in the 
market. The result is an increase in the sterling sight rate in foreign 
centers until it approximates or exceeds the gold export point. 

If affairs in the financial world are running along smoothly and the 
reserves of the Bank of England are at a satisfactory level, the Bank’s 
discount rate is of practically no significance. In normal times, very 
little rediscounting is done at the Bank by the bill brokers or the joint 
stock banks, because the Bank’s rate is above that prevailing in the 
open market. The Bank’s rate never falls below 2 per cent while the 
market, when carrying a large amount of surplus funds, may be willing 
to discount for as low a rate as 3/4 per cent. Clare, as a result of his 
study of the years 1881-1890, states that during that period the market 
rate averaged 7714 per cent of the Bank rate.1_ The failure of the 
market rate to move up and down in conformity with the Bank rate 
is partly due to the fact that bankers do not pay interest on all of the 
funds which they use, interest being paid only on interest-bearing 
deposits; banks therefore can afford to raise their rate of discount a 
little less than the Bank does. If a financial stringency strikes the 
London market and money becomes tight, the bill brokers andthe 
joint stock banks’have recourse to the Bank of England for rediscount- 
ing purposes. The Bank of England, however, must rely upon its own 
resources to stand the strain; also, when, because of adverse exchange 
rates, gold flows out of the country, it is the Bank of England’s gold 
reserves that are first affected. Under such circumstances, the Bank 
of England will raise its discount rate for the purpose of tightening 
the money market, conserving its own gold resources, or preventing 
the outflow and encouraging the inflow of gold. If, when the Bank 
raises its discount rate, the money rates in the open market do not 
rise as the Bank hopes they will, the Bank proceeds to “make its rate 
effective.” It enters the market as a borrower of funds, thus curtailing 
the available supply. During the early months of the World War, the 
Bank could not make its rate effective owing to the lack of commercial 
bills in the market and the great surplus of available funds. The open 
market discount rate on three months bills was as low as 1 3/8 per 
cent in February, 1915, while the Bank’s rate was 5 per cent. To 

1“ A Money Market Primer,” p. 140. 


GOLD AND GOLD MOVEMENTS 405 


remedy the situation, the Bank began borrowing from the joint stock 
banks in March. As a consequence of this action and also partly as a 
result of the issuance by the Treasury of a large amount of Treasury 
bills, which supplied a satisfactory form of investment for the surplus 
funds, it was able to control the rates in the money market most 
effectively. Another means sometimes used by the Bank to make its 
rate effective, is through the sale of governmental bonds “on account,” 
that is, to sell such bonds with the understanding that it may buy 
them back at a later date. Such sales remove a portion of the free 
capital from the market and thus tend to raise the open market money 
rates. 

If one were to plot two curves showing the fluctuations in the Bank 
rate and the flow of gold, the results would clearly show that, as a rule, 
when gold flows into England the Bank rate drops, and that when 
gold flows out of England the Bank rate rises. Normally, gold flows 
into England during the spring months because of payments made to 
English merchants by foreign buyers. As the summer months pass 
and autumn comes, England buys supplies of raw materials such as 
cotton, grain, etc., from foreign countries and as a result gold tends 
to flow out of the country. Thus in the spring of the year the Bank 
rate is low and gold imports are high; in midsummer the two factors 
more or less approach each other; and as the year closes the Bank 
rate rises and gold imports fall off. Clare, after making a careful 
study of the situation, concludes that “Taking one year with another, 
it may safely be said that a net gain to the Bank of a million from 
foreign imports corresponds to a 1 per cent drop in the rate, and a loss 
. of thatamount toarpercentrise. . . . It may be taken for granted, 
then, that the statistics of the Bank’s gain or loss of strength from the 
gold sent into or out of the country forms the best ground-work on 
which to base a forecast of the future course of the market; but at the 
same time it must not be assumed that the connection is always so 
close and clear as in the instance given. Due allowance must also be 
made for other influences, such as the general conditions of the market, 
the state of trade, the political outlook, etc., all of which are consider- 
ations that the Directors, doubtless, take into account before deciding 
on a change of rate.” ! 

As may be inferred, the frequent changes in the Bank’s rate exert 
a most disconcerting effect upon the money market. Stability in the 

1‘“A Money Market Primer,” pp. 70-71. 


406 DOMESTIC AND FOREIGN EXCHANGE 


discount rate of a central bank is an ideal much desired by those en- 
gaged in financial circles. The Reichsbank and the Bank of France 
likewise resort to a manipulation of the discount rate as a means of 
controlling the gold flow, but not to the extent that the Bank of Eng- 
land does. Taking the ten-year period, 1898-1907, the Bank of France 
changed its discount rate eight times, the Reichsbank forty-two 
times, and the Bank of England forty-eight times. Both the Reichs- 
bank and the Bank of France rely upon other methods than a change 
- in the discount rate to control the gold flow. Under abnormal con- 
ditions the discount rate of the Bank of England may fluctuate widely. 
The following table shows its discount rate from 1914 to date: 


1914 January 8 Thursday 44% 


22 4 
20 c 3 
July 30 4 
31 Friday 8 
August I Saturday 10 
6 Thursday 6 
8 Saturday 5 
1916 July 13 Thursday 6 
1917 January 18 af 5% 
April i & 5 
IQIQ November 6 a? 6 
1920 April 15 - ” 
1921 April 28 ES 6% 
June 23 i 6 
July 21 z 54 
November 3 oe 5 
1922 February 16 4 44 
April 14 4 


In commenting on these war-time fluctuations, the English Bankers 
Magazine of February, 1921,’ states that “Under the abnormal posi- 
tion created by the recent War, it has to be borne in mind that Bank 
Rate changes during and since the War were not accurate indications 
of current financial strain nor controllers of floating indebtedness 
between London and foreign centers as in pre-war times,” and it 
wisely adds that “until the gold standard is restored, in the future 
the Bank Rate must necessarily be largely considered as nominal.” 


1P. 198. 


GOLD AND GOLD MOVEMENTS 407 


As a means of protecting the gold holdings of the Bank of England, 
it has been suggested that instead of manipulating its discount rate 
the Bank should increase its price for gold. Gold responds very 
readily to a slight change in price. Although the Bank would cut into 
its profits if it paid a higher price for gold in times of need, nevertheless 
it is claimed that the adoption of the proposal would obviate frequent 
changes in the Bank rate, and thus remove a most disturbing influence 
in the business and financial circles of England. As noted above, the 
Bank of England pays about 76s. 414d. per ounce for full weight gold 
coins when 9/to fine. But coins are seldom full weight, so that the sum 
paid is generally 14d. less than that amount. At times the Bank has 
actually raised its buying price with most satisfactory results, while at- 
tempting to maintain its Bank rate unchanged. In May, 1801, for 
example, when, because of the then existing Russian situation, the 
Bank was compelled to prepare for the withdrawal of £3,000,000 or 
more in gold, it found that it could not procure the needed quantity 
of gold from Berlin or Paris and decided to attract gold from New 
York. On May 6, the directors of the Bank of England agreed to pay 
a premium of 1% cent over the customary price for American eagles. 
The premium was gradually increased until in the middle of the month 
the Bank’s price stood at 76s. 644d. In the market bar gold 11/r2ths 
fine was commanding 77s. 9 3/4d. The premium on American coin 
had the desired effect and during the month of May approximately 
$30,000,000 in gold was drawn from the United States. During this 
efflux, an American banker shipped several bars of gold and was sur- 
prised to learn that they were less acceptable than coin, because, as 
it was stated, when the fall movement of gold would set in toward the 
United States, the Bank of England would prefer to return gold coin 
than gold bars.! During the first week of June, the price was re- 
duced to 76s. 5d. and shortly thereafter the premium was abandoned. 
The plan had worked successfully. 

The central banks of Europe encourage gold imports by giving 
credit or making advances on gold while in transit. This was a rather 
customary practice of the Reichsbank before the war in order to care 
for the financial strain accompanying monthly or quarterly payments 
in Germany. Both the Bank of England and the Bank of France, as 
well as the Treasury of the United States, have at times resorted to the 
same method. In times of urgent need the Bank of France has been 


1 Commercial and Financial Chronicle, May 30, 1891, p. 810. 


408 DOMESTIC AND FOREIGN EXCHANGE 


known to pay a premium on any gold deposited with it, as in Novem- 
ber, 1921, when a premium of 1 per cent was paid. 

In addition to relying upon the discount rate as a means of checking 
gold exports, the Bank of France at times falls back upon its right 
to redeem its bank notes in silver five franc pieces instead of in gold 
coin, thus preventing exporters from reducing the gold holdings of 
the Bank. At the same time it may—and usually does—charge a 
premium for bar gold or for foreign gold coins.1 In October and 
November, 1907, when England, France, and Germany were being 
called upon for large amounts of gold, which either directly or in- 
directly found their way to the United States to relieve our financial 
stringency, the Bank of France charged a premium of 6/10 per cent 
for gold. The premium charged by the Bank is often prohibitive ? 
and compels the exporting firms to secure the necessary gold from the 
internal circulation of the country. Coins are collected by money 
changers from railway stations, hotels, etc., and disposed of to the 
exporting houses. This process entails time and expense, so that it is 
not unusual for the demand for exchange on London in the meantime 
to raise the rate considerably above the gold export point, although 
the rate always declines when gold begins to flow out of Paris. This, 
for example, was the case in December, 1899, when sight exchange 
on London rose to 25.40 francs per pound sterling because of the delay 
in securing gold for export.2 When the Bank of France charges a 
premium for bar gold or for foreign coins, the gold export point is 
raised because the premium adds to the expense of exportation. The 
possible loss on coins due to abrasion must also be considered. Ata 
premium of 4/10 of one per cent, exchange on London has to rise to 
25.425 before it pays the exporter to get gold from the Bank of France 
for export. It is because of the methods followed by the Bank of - 
France in preventing gold from being freely obtained for export pur- ~ 
poses that Paris has never been considered a free gold market. Some 
claim that it is that fact alone which has prevented it from becoming 
an important international financial center similar to London. 

The Reichsbank of Germany, as noted above, resorts at times to 


1 ‘The Bank of France always maintains a premium on gold for export purposes varying 
from 2% to 6 per mille (4% to 6/10%).” H. V. Burrell, English Bankers’ Magazine, 
1916, p. 210. 

2In November, 1912, a premium of nearly 34 per cent was charged on gold for export. 

3 Gold usually flows from Paris to London in normal times if the sight rate rises to 25.32 
francs per pound sterling. 


GOLD AND GOLD MOVEMENTS 409 


changing its discount rate so that it may control gold movements, but 
it may also use two other means not availed of by either the Bank of 
France or the Bank of England. If gold is demanded from the Reichs- 
bank for export and the Bank feels that the yellow metal should be 
retained in the country, it interposes objections of one sort or another 
or delays payment or appeals to the patriotism of the exporter. The 
Reichsbank is required at all times to redeem its notes in gold and, 
except during and since the World War, it. has always done so. But 
banks and bankers of Germany do not draw upon the gold holdings 
of the Reichsbank if it objects to such loss. Instead, gold will be taken 
from the circulation of the country, which entails time and expense, 
so that exchange rates may exceed the gold export point for some 
time before the gold outflow becomes sufficiently large to affect the 
situation. The Reichsbank, and the Bank of Belgium as well, also 
follow the policy of keeping on hand a large supply of foreign bills of 
exchange which may be used for protection when occasion demands. 
The Reichsbank usually holds a large amount of sterling drafts to- 
gether with some French drafts; the Bank of Belgium invests more 
heavily in French bills. These holdings are accumulated or replen- 
ished when exchange rates are low. If the rates of exchange rise so high 
that gold exports are apt to occur, the bills are sold in the local market, 
thereby creating a supply of exchange and lowering the rate below 
the gold export point. Also, if it is advisable to encourage gold im- 
ports, the rate may be forced down until it is below the gold import 
point, thereby causing gold to flow into the country. 

Another method sometimes followed for the purpose of preventing 
gold exports is to have the nation or the central bank obtain loans in 
a country to which the gold should normally flow, and then sell ex- 
change against the bank accounts thus created in that country, thereby 
adding to the supply, weakening the rate, and thus preventing gold 
exports. Or, again, such loans may be used for the same purpose but 
as a means of decreasing the supply of exchange ov the borrowing 
country and so removing a most important weakening influence. 
Thus during the World War the Allies obtained loans from the United 
States, and the proceeds were deposited in New York banks. American 
firms selling goods to the Allies drew dollar drafts against those ac- 
counts. The drafts, being on dollar accounts and paid in the United 
States, did not add to the supply of exchange in the United States on 
the allied countries, as would have been the case had the drafts been 


410 DOMESTIC AND FOREIGN EXCHANGE 


drawn on foreign accounts in sterling, francs, lire, etc. The exchanges 
were thereby relieved from what would otherwise have been the crush- 
ing and overwhelming weight of an untold amount of drafts drawn 
in foreign monies with no possibility of the Allies offsetting our claims 
on them by their claims on us, as would normally have been the case. 
We were selling to them but they were not selling to us. Such loans, 
however, merely postpone the evil day, because they must be paid 
sometime, and at maturity become a powerful influence tending to 
reduce exchange rates in the lending country to the gold import 
point. 7 

It is not unusual for arrangements to be made between bankers for 
the “earmarking” of gold, thus making its shipment temporarily 
or permanently unnecessary. During 1917 the American dollar was 
at a discount in Argentina because of our adverse balance of trade 
with that country. Gold was destined to leave the United States in 
large amounts, even to the extent of possibly handicapping our par- 
ticipation in the European War. Not long after the outbreak of the 
European War, Argentina passed a law enabling American importers 
to make payments to the Argentine Ambassador in the United States, 
who deposited the proceeds with the Federal Reserve Bank of New 
York. Payments by Argentine importers were deposited with the 
Banco de la Nacion in Buenos Aires. Claims of the merchants of one 
country against those of the other were cleared through the two banks, 
obviating, so far as possible, the shipment of gold. This law had 
lapsed, but as a result of the dollar being so greatly at a discount in 
Argentina, the Secretary of the Treasury of the United States asked 
that the law be revived, which was done, and on January 7, 1918, he 
announced that an agreement had been reached with Argentina 
whereby the dollar rate on that country was to be stabilized at a little 
higher than the gold export point. Payments were to be made to the 
account of the Argentine Ambassador with the Federal Reserve Bank 
of New York at the rate of three per cent above par to cover costs of 
transportation, insurance, etc., which would have had to be paid had 
gold been shipped. The American importers were thereby saved a 
premium of approximately seven per cent. We were also able to keep 
our gold in the United States. Following the Armistice the Argentine 
account was gradually withdrawn, the arrangement being terminated 
in 1920. | 

Another instance of the “earmarking”’ of gold occurred in 1919 when, 


GOLD AND GOLD MOVEMENTS "ATS 


the Federal Reserve Bank of New York, acting on behalf of all of the 
Federal Reserve banks, purchased from the United States Grain 
Corporation about $173,000,000 worth of gold. This gold had been 
sent to the Bank of England from Germany as gold marks and after 
being reduced to bars had been “earmarked” by the former for the 
account of the Federal Reserve Bank of New York. The latter, from 
time to time, sold varying amounts of the gold to banks and bankers 
in the United States who desired to export metal to various parts of 
the world, and who were willing to take it from London. During the 
summer of 1920, the remainder of the account (approximately $61,- 
500,000) was brought back to the United States by the Federal Re- 
serve Bank of New York. Gold deposited in other countries makes 
importation or exportation unnecessary because it can be used just as 
satisfactorily for reserve or for other purposes as though it were actu- 
ally on hand.! In the next chapter we shall discuss the policy followed 
by India in stabilizing her monetary system and her exchanges by 
using gold reserves kept in England. During the war the gold held 
for Argentina by the Federal Reserve Bank of New York was em- 
ployed by that country as security for the issuance of paper currency. 

When one coldly considers the matter, one can see how very foolish 
we are in continually importing and exporting gold, the same gold 
frequently coming into the country and then, as the exchanges shift 
a few weeks later, being sent back again to the place whence it came. 
Japan and Russia have consistently kept a large gold deposit in other 
countries. In 1912 it is stated that Japan held at least $175,000,000 of 
gold in the United States and London. At one time in 1917 she had 
over $287,634,000 to her credit in New York banks. “The economic 
gain to Japan by this operation is measured by the saved cost of 
transporting the gold. This includes freight, insurance, loss of inter- 
est, brokerage, packing, and the petty incidental expenses which 
would amount to one-half of 1 per cent or more of the value involved, 
or approximately $1,438,170.” R. H. Tingley has estimated that 
from 1895 to April, 1917, it cost us $19,850,583 to ship $3,970,116,765 
in gold back and forth across the water, or at the rate of approximately 


1 Realizing that fact, the Federal Reserve Board in September, 1917, issued a request 
that all banks notify it of any gold that was being held “‘earmarked ” for foreign account. 
It was feared that banks might be holding large sums for enemy countries. The Board 
declared that such earmarking was considered as ‘‘tantamount to the exportation of gold, 
and that in public interest it requests that no more gold be earmarked for foreign account 
except upon the approval of the Board.” 

2The Annalist, July 2, 1917. 


412 DOMESTIC AND FOREIGN EXCHANGE 


$890,000 a year.! The universal adoption of the policy of earmarking 
or depositing gold in important financial centers, or the establishment 
of an International Gold Settlement Fund, would save this unneces- 
sary burden to the financial and commercial world. 

To reduce the costs of shipping gold it is not unusual for it to be sent 
from one country to another for the credit of a third. For instance: 
In 1909 England owed Argentina for wheat; we owed England for 
securities which we had purchased from her. We shipped gold to 
Argentina (to the extent of about $61,000,000 during that year) 
but for English account. To be reimbursed we drew drafts against 
England, and sent them to England for collection. We then sold 
drafts on those accounts to those Americans who had purchased 
securities from England and who had to remit exchange for payment. 

In normal times, the flow of gold acts as a corrective in keeping ex- 
change rates fluctuating between the gold points. If the rates are so 
high as to make the exportation of gold profitable, gold will be exported, 
foreign credits will be built up, and drafts drawn against them. The 
supply of exchange in the market is increased, unless the demand grows 
as rapidly as the supply. If the demand for exchange does not in- 
crease at least proportionately the result of the increased supply of 
bills will be a weakening of the exchange rate, thus tending to pull it 
back below the gold export point. Gold exports reduce bank deposits, 
curtail credit, and tend to tighten the money market. This state of 
affairs raises or tends to raise money rates, “provided other things 
remain equal,” 1. e., provided there is not at the same time a marked 
decline in the demand for money. Higher money rates make it more 
worth while to keep funds at home and to bring funds back from foreign 
markets. The recall of funds is accomplished by the sale of exchange. 
If too large a supply of exchange is thrown onto the market, the ex- 
change rate declines to a point where gold may be profitably imported. 
Bankers will then be in the market as demanders of exchange to be 
sent abroad and used for the purchase of gold for importation. This 
demand for exchange will, “if other things remain equal,” tend to raise 
the rate above the gold import point and bring it back somewhere 
near the par of exchange. Gold imports increase bank deposits and 
increase credit facilities, and thus tend to reduce money rates, pro- 
vided “other things remain equal.” But if the money rates fall below 
those prevailing in other centers, exchange will be demanded with 


1 American Industries, November, 1917, p. 11. 


GOLD AND GOLD MOVEMENTS 413 


which to shift accounts to those centers. The demand for exchange 
may cause the exchange rate to rise high enough to make gold ship- 
ments profitable. So runs the universally accepted theory as to the 
corrective influence of gold movements. 

During periods of war when it is inadvisable to ship gold because of 
the danger of capture at sea by the enemy’s navy, or when in times 
of either peace or war, the government refuses to allow gold to be 
shipped out of the country, or refuses to redeem its paper money in 
specie, or does anything else to interfere with the free movement of 
gold, the flow of gold cannot act as a corrective to adverse exchange 
rates. “Gold points,” under such circumstances, have no significance. 
During and since the war, “normal” conditions have not prevailed. 

For several months before August, 1914, Germany and France were 
especially active in building up their gold stores, realizing that a break 
in international relations was likely to occur. With the beginning of 
hostilities all countries mobilized their gold holding for most effective 
use because they all realized that gold was the very foundation upon 
which their financial structure rested. Gold imports and exports were 
immediately placed under governmental control, either legally or to 
all intents and purposes. Specie payments were suspended and large 
issues of paper money flooded the market places. The United States, 
being the last to enter the contest, was the last to interfere with the 
movement of gold. Not till September 7, 1917, did it do so by placing 
the control of the exchanges with the Federal Reserve Board. We were 
also the first nation to abandon restrictions on gold movements, which 
we did in June, to1g.'_ At this writing, European nations are still 
controlling gold movements through various regulations and govern- 
mental machinery,” so that the “gold points” no longer function as 
they normally would. Nor has the enormous amount of gold that has 
been sent us succeeded in bringing the exchanges of foreign countries 
back to their customary levels. There are probably two reasons for 
this: first, the amount sent us is but a small part of the sums owing 


1 Except on exchange transactions with Soviet Russia or in rubles or to countries to 
which money could be sent only through the American Relief Administration. All re- 
strictions were finally removed on December 18, 1920. 

2 According to the weekly circulars of Samuel Montagu and Company of London, under 
date of February 9, 16, and 23, 1922, the export of gold is prohibited in the following coun. 
tries: Argentina, Mexico (coins), Syria, Hungary, Jugo-Slavia, Poland, Rumania, Sweden, 
and Turkey, while in the following countries a government license is required, Australia, 
Canada (until July, 1922), Chile, Cuba, England, Japan, Mexico (gold bars), Austria, Bel- 
gium, Bulgaria, Czecho-Slovakia, Denmark, Finland, France, Greece, Italy Luxemburg, 
Netherlands, New Zealand, South Africa, and Switzerland. 


44 DOMESTIC AND FOREIGN EXCHANGE 


us by foreign countries; and second, the depreciation of the exchanges 
is due primarily to the large issues of paper money by foreign coun- 
tries, and such depreciation will continue until they get back again 
to a gold standard basis. The erection of tariff walls to prevent 
“dumping” by Germany and to protect “home” industries against 
foreign products has also interfered with the free working of economic 
forces that otherwise might have enabled foreign nations to pay in 
goods rather than in gold, and thus might have assisted in the con- 
servation of their gold supplies and in a more rapid return to the gold 
standard and normal exchange levels. Since August, 1914, rates of 
exchange on many countries, though greatly below our gold import 
point, have been of no significance as affecting gold flow. Gold has 
come to us from the Allies only when they have wished to send it. 
Since the war they have not had enough gold available to send to 
bring their exchanges back to normal. They have forwarded the yellow 
metal only as it has pleased them to do so, never with any idea 
that such shipments would relieve the serious discount on their ex- 
changes. 

The following table tells the story of the gold movements since 
August, 1914, at least so far as the United States is concerned: 


TABLE XIII 


GoLD Exports AND Imports, UNITED STATES 


August, 1914, to December, 1921 
Excess of Im- 


Imports Exports ports 
Aug. 1, 1914, to Dec, 31, 1914... . 23,253,000. 104,972,000 | 81) 71G mean 
Jan. 1, 1915 to Dec. 31, 1915... ..451,955,000 31,426,000 420,529,000 
Jan. 1, 1916 to Dec. 31, 1916.....685,745,000 155,793,000 529,952,000 
Jan. 1, 1917 to Dec. 31, 1957...- 553,713,000 372,571,000 TOT .agioee 
Jan. 1, 1918 to Dec. 31, 1918..... 61,950,000 40,848,000 21,102,000 
Jan. 1, 1919 to Dec. 31, 1919..... 76,534,000 368,185,000 291,651,000 2 
Jan. 1, 1920 to Dec. 31, 1920... ..417,068,000 322,091,000 94,977,000 
Jan. 1, 1921 to Dec. 31, 1921.....691,267,000 23,891,000 667,376,000 


1 Excess of exports. 


From August 1, 1914, to December 31, 1921, we imported $1,542,- 
119,000 more gold than we exported. During that period only two 
years, viz., 1914 and 1919, showed an excess of exports. The excess 
exports of 1914 were due to the efforts which we made at the beginning 


GOLD AND GOLD MOVEMENTS 415 


of the war to pay our obligations to our European creditors who gave 
us no opportunity of offsetting our indebtedness to them by our claims 
upon them because of the moratoria which were declared at the out- 
break of hostilities. In 1919, the greater part of our gold exports went 
to the countries of the Far East to pay for products which we had pur- 
- chased during the war, or was shipped out to those nations (Japan 
and Argentina) for which we had “earmarked” gold during the period 
of the embargo. In the export movement of 1919 Japan received 94.1 
millions; China, Hongkong, British India, Straits Settlements, and 
Dutch East Indies, over 125 millions; Argentina 56.6 millions; 
other South American countries, 33 millions; Spain 29.8 millions; and 
Mexico 10.4 millions. An interesting phase of the 1919 situation was 
that in spite of our exports of gold, our excess exports of merchandise 
amounted to over $4,000,000,000, not to mention the huge excess ex- 
ports of the preceding year. We shipped to other nations approxi- 
mately $291,000,000 of gold and $150,000,000 of silver more than 
we imported. A cry went up from many sources to the effect that our 
banking and credit structure could not long withstand the effects of a 
steady drain of that character. The Guaranty Trust Company in a 
leaflet on ‘The Gold Situation,” issued at that time, declared that: 


“The domestic credit stringency has been reflected in declining reserve 
ratios at the Federal Reserve Banks and has been in part caused by absolute 
losses of gold in these reserves. The Reserve Banks have raised their dis- 
count rates to the highest figures since the inauguration of the Federal 
Reserve System. As a consequence, credit liquidation has occurred, at the 
expense of both foreign and domestic credits. 

“There are those, who in the light of these conditions, view with certain 
alarm the continued export of gold. They feel that, while deflation is un- 
doubtedly necessary, it should take place gradually and not be unduly 
forced and accelerated by large losses of gold, the foundation of our mone- 
tary and credit structure.” 


In spite of the widely expressed fears and warnings, we kept our 
gold market free and allowed gold to flow in unlimited amounts and 
without restriction to any country that could take it. The stream, 
however, soon turned and in 1920 we again had an excess of gold im- 
ports approximating $94,977,000, and in 1921, a still larger excess of 
$667,376,000. At this writing (April, 1922) gold is still flowing into 
the United States, about two-thirds of the supply coming from Eng- 
land, France, and Sweden. That coming to us from England is and 


416 DOMESTIC AND FOREIGN EXCHANGE 


for some time has been largely the new gold produced in the English 
colonies, which has been shipped to London and forwarded to us in 
the manner described above.t That which France and Sweden have 
sent has come for the most part originally from the gold stock of Soviet 
Russia. Authorities maintain that at least $100,000,000 of Russian 
gold has been sent to us via England, France, Switzerland, and other 
European countries.» How long this stream of gold will continue to 
pour into the United States cannot be surmised, but, as the Federal 
Reserve Bulletin of June, 1921,* remarks, “. . . so long as present 
exchange conditions prevail, and that means so long as the balances 
of international payments continue to be favorable to America, there 
is every reason to believe that most of the new gold produced in the 
world will find its way to the United States.”” These gold imports have 
materially strengthened the European exchanges and have aided in 
easing up our domestic money market. No one can estimate how 
much gold will still have to be sent to us in order to bring the depre- 
ciated exchanges back to their normal positions, but, needless to say, 
imports of gold alone will not suffice. Other measures, relating pri- 
marily to internal monetary, industrial, and financial conditions, 
must also be adopted by the European countries before matters 
can be brought back to normal. 

A large portion of the gold that came to us during 1915-1918 served 
two distinct purposes; first, it paid for commodities which the Allies 
were purchasing from us, and second, it afforded the basis for credit 
expansion, and thus eased up our money market, thereby facilitating 
the flotation of loans to the Allies. These shipments of gold were usu- 
ally so timed as to have the desired effect upon our money rates. The 
Allies had to borrow from us and it was necessary for them to keep 
the money market in an “easy” condition. They knew that money 
rates had to be kept low in the United States in order that we might 
more readily invest in their offerings. So whenever our money market 
gave evidence of stiffening,* or when our stock market became slug- 


1 Cf. pp. 379-380. 

2 Federal Reserve Bulletin, June, 1921, p. 681. 

* Pp 681. 

4 Typical of the statements appearing in the American press in reference to this matter 
is the following from the New York Journal of Commerce and Commercial Bulletin of De- 
cember 5, 1916. ‘Gold is being rushed here from Canada to bring about a relaxation 
in the local currency market, which was featured yesterday by a sensational advance in 
call loans to 15 per cent, the highest rate in over three years.” The same periodical under 
date of July 18, 1916, comments upon the reasons for such gold imports in the following 
manner: ‘‘The extent of the importations certainly suggests how fully alive the British 


GOLD AND GOLD MOVEMENTS 417 


gish, gold was sent to the United States, to pave the way for additional 
sales of securities or flotation of loans. With the same objects in mind, 
England even went so far as to interfere with our gold exports to 
Spain, the Orient, and to South America. British steamship com- 
panies, evidently acting under orders from their government, refused 
to carry substantial amounts of gold from the United States to ports 
of the Far East. English underwriters raised their insurance rates to 
levels so high that gold exports were unprofitable. The Chancellor 
of the Exchequer forbade British banks or their branches in South 
America to receive any gold that we might forward, so that we were 
compelled to ship solely to neutral correspondents. The Avzmnalist 
of January 1, 1917, quoted a prominent foreign exchange dealer as 
saying that 


“The British authorities, of course, cannot stop the movement to Ar- 
gentina, but they can retard transfers. American banks and trust com- 
panies will continue to send gold to neutral correspondents, but they cannot 
ship as much as would be possible if gold could be sent in British bottoms. 
Also the manner of insurance enters into the situation. Local underwriters 
put a limit upon the risks they will take, and if a banker desires to send 
more gold than American underwriters are willing to insure, an effort to 
take out the additional insurance in London finds rates so high that they 
are prohibitive. With South American exchange at a premium here, bankers 
would like to get the profit they see in gold shipments, but these profits 
quickly melt away if insurance costs rise to a stiff figure. 

“The British Treasury is anxious to keep all the gold here which is here 
because of the effect its presence has on money rates. The allied Govern- 
ments need to keep money as cheap as possible because of the vast ac- 
commodations in credits and loans they need month after month.” 


American ship brokers were also warned by England that they should 
not ship gold to Spain. “Investigation showed that several heavy 
shipments of American gold were held up as the result of the British 


Treasury officials are to the necessity of keeping down money rates at the American centers. 
In no other way can they maintain sterling exchange rates on its present parity. More 
remunerative figures would necessarily cause the withdrawal of American funds from 
London. At the same time they would give a black eye to the investment situation, a de- 
velopment particularly unfortunate to British financial plans. It would prove an adverse 
feature in three distinct aspects. In the first place it would mean much lower prices for 
those American securities which the British Treasury still is prepared to sell outright. 
Secondly, it would interfere with the large loans based on American securities as collateral 
already placed on behalf of the British Treasury with American banks, trust companies 
and other lenders. Thirdly, it would especially be inopportune since it would prove a 
severe handicap to the new British loan arrangement so soon to be announced.” 


? 


418 DOMESTIC AND FOREIGN EXCHANGE 


order. The shipowners fear blacklist or even confiscation of the 
shipment.” 1 A large shipment of gold which American bankers 
forwarded to Holland in 1915 was confiscated by England, but later 
returned to its rightful owners.” 

As a consequence of developments during and after the Great War, 
a decided change occurred in the distribution of the world’s stock of 
gold among the central banks and the various governmental agencies 
of the principal countries. The proportions held by the more impor- 
tant nations at the close of 1913 and 1918, and in April, 1921, are 
shown in the following table: * 


Percentages of Distribution 


1913 Ig18 1921 
United sstatestesin'. 1.0 21.74 37.74 37.00 
United Kingdom........ Eis 8.80 II.16 
Bib Vale ah te eek Oe PRM Ge Qi. BA Tia 10.07 
Italy vee eee ey. at veok 9.06 4.09 3.46 
SOTA ee ees eee 8.76 9.06 3.80 
SPEND TRAE Lai eee ean 2.91 7.24 7 ,Or 
A GAniadia wetter. 5 Sok. 4 ats 3.63 2.04 1.22 
Arwentilia er oe ae cle ae Vie 4.53 6.59 
JET cee ey che Becta 254s 2.04 3.79 8.17 


It will be noted that the gold reserves of the United States increased 
from 22 per cent of the total in 1913 to 37.74 per cent in 1918, and then 
decreased slightly in 1920. For January, 1922, it was estimated that 
the total stock of monetary gold in our country amounted to $3,657,- 
000,000 as against $2,245,720,000 in 1918, or about 4o per cent of the 
world’s stock.* 

In face of the huge excess of gold imports, shall we say “enjoyed” 
by the United States since August 1, 1914, one may be justified in 
raising the question whether or not a country can ever possess too 
much of the yellow metal. In the days of the dominancy of the mer- 
cantilist philosophy (approximately 1500 to 1750), it was maintained 

1 San Francisco Examiner, January 20, 1917. 

2In January, 1916, with the then high rates for guilders, American exchange dealers 
could have cleared a profit of more than 6 per cent on gold shipments to Holland, had Eng- 
land permitted such shipments to be made. The English government was ‘“‘averse to 
permitting shipments from other nations, lest this gold should ultimately get across the 
border and help strengthen German bank reserves.” The Annalist January 24, 1916. 

3 Federal Reserve Bulletin, June, 1921, p. 676. 


4 Monthly Review of Credit and Business Conditions in the Second Federal Reserve District, 
February I, 1922, p. 5. 


GOLD AND GOLD MOVEMENTS 419 


that a country should so shape its affairs as to acquire a “store of 
treasure,” the treasure being composed of the precious metals. Just 
as a man is counted wealthy if he has a supply of money on hand, so 
a country was to be counted wealthy if it had a hoard or store of 
precious metals in its possession. That country was the wealthiest 
and in the best condition that had the largest store of treasure. To 
obtain the precious metals it was urged that a nation should adopt 
certain economic policies such as encouraging exports and discourag- 
ing umports of merchandise thus securing a favorable balance of trade 
with a resulting inflow of treasure; restricting exports of gold and silver; 
developing the merchant marine; protecting and regulating home 
industry, etc., etc.' Many of the ideas advanced by the mercantilist 
writers are dominant today. ‘Trade at home;” “Buy goods made 
in the United States”’; the protective tariff; the joy of politicians and 
others over a favorable balance of trade; the stress laid upon the 
necessity and advisability of developing foreign trade and a merchant 
marine; the exultation disclosed in newspaper and magazine articles, 
speeches, etc., over the fact that the United States now holds more 
than one-third of the world’s gold stock;—these and similar matters 
are indicative of the widespread acceptance of ideas abandoned cen- 
turies ago by European nations when they embarked upon the policy 
of laissez-faire. The mercantilists maintained that a nation could 
never have too large a supply of the precious metals. Later economic 
writers have held to the contrary point of view and have based their 
contention chiefly upon certain propositions advanced by Ricardo. 
Ricardo maintained that when the precious metals are allowed to flow 
freely between nations the result will be an apportionment of the 
world’s supply of gold in accordance with the needs of each individual 
nation. Ricardo was concerned with the precious metals rather than 
with gold alone, because in his time the prominent nations of the world, 
almost without exception, were still on a bimetallic basis. Today, 
however, gold is the standard among most nations, so that we may 
omit all mention of silver in the present discussion. 

The apportionment suggested by Ricardo is supposed to be worked 
out in somewhat the following manner: If, because of a continuing 
favorable balance of trade, gold flows into a country, say the United 
States, an oversupply of gold results and gold falls in value, i. e., its 
purchasing power decreases, the converse of which is a rise in prices. 

1 Cf. Schmoller, G., “The Mercantile System and Its Historical Significance.” 


420 DOMESTIC AND FOREIGN EXCHANGE 


Money rates also weaken. Foreign nations find it increasingly hard 
to purchase goods from us at our higher level of prices. Their exports 
of gold to us have in the meantime brought about a decrease in their 
own price levels. They start purchasing at home, and thereby reduce 
both the favorable balance of trade of the United States and our gold 
inflow. The merchants of the United States find that prices have be- 
come lower abroad than at home and begin purchasing from foreign 
nations. An unfavorable balance of trade results; gold flows from the 
United States; foreign countries now begin to have an excess of gold 
imports; money rates stiffen in the United States because of the gold 
outflow. Gold, because of its scarcity, becomes more valuable with 
us and commodity prices fall; while abroad, gold, because of its abun- 
dance, becomes cheaper and commodity prices rise. If the foreign 
nations in their turn receive more gold than they should “naturally” 
have, prices will rise to too high a level, merchants in the United States 
will stop buying abroad, foreign merchants will buy in the United 
States because of the lower price level existing here, gold will flow in 
to us, prices will rise, and so on ad infinitum. Asa consequence of this 
freedom of gold movement, it is claimed that gold flows from one 
country to another, tending to give each its needed quota, and bringing 
about a fairly uniform level of prices among all nations. Necessarily 
the theory should be considered as applying only to those goods that 
play a part in foreign trade, because goods that are neither exported 
nor imported should not enter into any calculations concerning inter- 
national trade relations. 

The theory as outlined is correct as a theory, provided one approves 
of the more or less universally accepted quantity theory of money, 
which, stated in its more widely accepted form, holds that “increasing 
the media of exchange tends to increase prices provided other things 
remain equal.” As gold flows into a country it increases the available 
media of exchange, first by being used as money, and second—and 
this is the more important of the two—by being used as a reserve be- 
hind deposits, against which checks and drafts may be drawn. Contra, 
as gold leaves the country, it reduces the available media of exchange 
by (a) curtailing the gold coin in circulation and (b) reducing re- 
serves and therefore bank deposits. The quantity theory as more 
generally accepted concerns itself only with the media of exchange 
that are zn circulation. One must not think, however, that the media 
of exchange in circulation cannot increase unless we have gold im- 


GOLD AND GOLD MOVEMENTS 421 


ports, or that gold imports must always increase our media of exchange 
in circulation. Today about go per cent of our financial transactions 
are handled by means of credit instruments—not by hard cash, as was 
the case in Ricardo’s day. It is therefore possible for our media of 
exchange to increase and decrease regardless of the gold movement, al- 
though, inasmuch as credit instruments are based ultimately upon a 
metallic reserve of some sort, usually gold, it can be seen that gold 
imports may facilitate the issuance of an additional amount of credit 
instruments. This, as stated above, does not necessarily occur. The 
imported gold may be “earmarked”’ for another country and there- 
fore not. become available for use by the importing nation, or it may 
merely be stored away in the vaults of banks and not used to increase 
the amount of checks, drafts, etc., in circulation. During 1920 and 
1921, gold came to us from other nations in millions of dollars, money 
rates fell, but prices, instead of rising, tumbled downward following 
the spring of 1920. In fact, instead of bringing about high prices and 
thus making it harder for foreign nations to buy from us, our tremen- 
dous gold imports have strangely enough been accompanied by just 
the reverse effect. Prices have fallen in spite of gold imports—of 
course not because of them; just why they have fallen need not con- 
cern us here. At the same time gold imports strengthened foreign ex- 
change rates, giving the foreign monies a greater purchasing power than 
they had had following the unpegging of the exchanges in March, 19109, 
which, of course, meant lower prices to foreign purchasers. On the 
other hand, one must not overlook the fact that if the foreign nations 
should at any one time send us all the gold that they can spare, and 
then could send no more, their exchanges would decline because gold 
could no longer be sent to maintain them; their money therefore 
would buy less in the United States because of the depreciated ex- 
changes. Our prices to the foreign nations would rise, primarily be- 
cause of this lack of gold imports, although prices would not neces- 
sarily, and might not at all, rise so far as citizens of the United States 
were concerned. 

Another circumstance that is of interest in this connection is that 
during the year 1919 we exported $291,651,000 more gold than we 
imported. Prices should have fallen, or have shown a tendency to 
fall, yet they continued to rise to higher levels. This may possibly 
be accounted for by the fact that during the four preceding years we 
had had a large excess of gold imports, although during 1918 the ex- 


422 DOMESTIC AND FOREIGN EXCHANGE 


cess had amounted to but $21,102,000. One naturally raises the ques- 
tion as to just how long it takes an excess of gold imports to affect 
prices.! Authorities disagree slightly but usually maintain that there 
is a lag of from one to three months between an increase in the per 
capita of circulation and an increase in prices.?, The per capita in 
circulation should include all things that are employed as media of 
exchange. The accompanying chart (Chart VI) and table (Table XIV) 


SEER SE aaa 

SA ae ae a 

ARERR SR 
PLE | 


SERGGEROER) im 
SARREROEEE0 
FANGATAN SD ANI 
EO LEEPPE LTE 





| oe 


Say) y pe sors Bt Coen 


/CS Wane INOEX 


Cuart VI 
Gold movements and wholesale prices, United States, 
1890-1921 


disclose the fact that other instances than those cited above may show 
that gold movements and prices do not always move in the direction 
that would harmonize with the above theory. On Chart VI the data 
covering our gold imports and exports for the fiscal years 1890 to 1918, 
inclusive, and for the calendar years 1919 and 1920, have been plotted 
alongside of the wholesale price index number of the United States 
Bureau of Labor Statistics. During thirteen out of the thirty years 


1Gold imports may almost immediately affect the per capita of media of circulation 
because gold is exchangeable for money at the mint after a lapse of a few days, which 
money may be put into circulation or used as reserves behind deposits. 

2 Fisher, I., “Stabilizing the Dollar,” pp. 29-30. 


GOLD AND GOLD MOVEMENTS 423 


TABLE XIV.—GoLpD MOVEMENTS AND WHOLESALE PRICES 
United States, 1890-1921 


Wholesale Prices 
| Excess Exports | Excess Imports | U. S. Bureau of 
Year Ended June 30 of Gold ' of Gold 3 pu eed 
1913 = 100 

Mr reres rnd ns as 4,331,149 81 

eet ees vee eas 68,130,087 8I 

RN ee eka vee eS oe 495,873 75 

8 Sk ae ee 87,506,463 77 

SOLO a 4,528,942 69 

MTOR als ss. 30,083,721 69 

Oly Sis En 78,884,882 66 

RUE alia. cles woe 44,653,200 66 

2 @ ees ee 104,985,283 69 

Rt eas ey od 51,432,517 74 
vee) Sts Ge aa ana 3,693,575 80 

a)... Be eer 12,866,010 79 

OE GOR ee 3,452,304 85 

MAM sarah eae Weise wk bs 2,108,568 85 

CON 4, 5 ee As ome 17,595,382 86 

Orc) SNARE eee 38,945,063 85 

Re he ole oo's Great 57,048,139 88 

ee) Sse ae Mie ge gee © 63,111,073 04 

eo ree ry te al dele Scualss iat 75,904,397 QI 

EMA tion's asin hs, oN ss 47,527,820 97 
OE eee er ci Sate ave io x rhe PEP RK 99 

ep he SSE OA rapt te? 51,097,360 95 

DOR” cis PERE Taint Sse 8,391,848 IOI 

tT is a Sd ene 8,568,597 100 

PMT sos wlan gi ety ea 8 45,499,870 100 

RC sid EN pint ites: 25,344,607 IOI 

OEE ft ou hi. 3 aged s 403,759,753 124 

TO Ae Re ane 3 685,254,801 176 

Mg od a dies Mo stmcals 74,087,070 ? 196 

RMLs 0 05758 0%, ahd om 201,051,202 * 212 
SI 2s 5, 6 5 x snes 94,977,065 * 243 


1 Statistical Abstract of the United States, 1920, p. 530. Federal Reserve Bulletin, 
February, 1922, p. ooo. Figures prior to 1895 relate to coin and bullion; subsequent to 
that date, they include ore also. 2July 1, 1917, to Dec. 31, 1018. *% Year ended Dec. 31. 


424 DOMESTIC AND FOREIGN EXCHANGE 


in question, the two movements moved in opposition to the theory 
that we are discussing. Is not one justified, therefore, in questioning 
the general theory that excess gold imports raise prices and that 
excess gold exports lower them? ‘The theory has to be discussed and 
accepted, if accepted at all, as one of those “provided-other-things- 
remain-equal” theories. “If other things remain equal’ and excess 
gold imports result in increased bank deposits, loans, discounts and 
an increased per capita circulation, and if employment is general and 
demand for goods is great, and if industry is booming and markets 
are active, then excess gold imports may tend to raise prices. On the 
other hand, “if other things remain equal” and excess gold exports 
reduce bank deposits, loans, discounts and the per capita of circula- 
tion, and if unemployment becomes widespread, industry stagnant, 
demand for goods lacking, etc..—then excess gold exports may tend 
to reduce prices. But even so, are we not stressing too much the in- 
fluence of gold movements upon the price level and at the same time 
overlooking the influence of certain other very important factors? 

But to revert to our earlier question as to whether or not any country 
at any time may be possessed of too much gold, either for its own good 
or for the good of those countries with which it trades, we are forced 
once more to deal with certain non-conformities between theory and 
fact. The early mercantilists naturally claimed that it was impossible 
for any country to have too large a supply of gold, the larger the supply 
the wealthier the country, the better was the lot of its people, etc. 
Our later economists, however, have tended to stress quantities of 
goods rather than gold, production rather than accumulation, health, 
happiness and the general welfare of citizens rather than a store of 
precious metals, and free trade rather than protective tariff or a con- 
tinuing favorable balance of trade. But the theory or point of view 
that is commonly accepted by the people and acted upon by their 
governments is more nearly in accord with the doctrines of the mer- 
cantilist writers. 

Never before the World War had a country ever been known to 
object to an excess of gold imports or to a continuing favorable balance 
of trade. Economic and political policies have almost always been 
shaped with the idea of attaining both of those objects. During the 
war, however, the public was amazed and dumfounded when Sweden, 
Norway, Denmark, Holland, and Spain, all neutrals, one after an- 
other announced that they had acquired too much gold and that steps 


GOLD AND GOLD MOVEMENTS 425 


would be taken to prevent further importations. The influence of too 
much gold, it was said, had resulted in credit inflation, high prices, 
speculation, etc. On February 8, 1916, the Swedish Riksdag freed 
the Bank of Sweden from the legal obligation of purchasing bullion 
delivered by anyone to the Swedish mint.! The law had compelled 
the Bank to purchase a kilogram of gold from any person presenting it 
at the price of 2480 kronen less 1/4 per cent or 2473.80 kronen net. In 
1916, as a result of the large supply of gold in the country, a kilogram 
could be purchased in the open market for 2200 kronen. The Bank 
was put in a serious situation because of the large amounts of gold 
which it was forced to buy at a price higher than that in the market. 
The law was therefore changed to give the needed relief. Shortly af- 
terward, Denmark and Norway followed Sweden’s example. These 
countries wanted goods or securities, not gold. In the case of Spain, 
the Bank of Spain was the only institution authorized during the war 
to import gold, and, as all shipments had to be made direct to it, the 
Bank had complete control of the market. When conditions within 
the country began to show the effect of too much gold, the Bank re- 
stricted imports by imposing an arbitrary purchase price on gold coin 
that really amounted to about a 6 per cent discount (American gold 
being accepted at the rate of 4.90 pesetas to the dollar instead of the 
mint par value of 5.18); and also by refusing to purchase gold bullion. 
In the case of none of the neutral countries mentioned was the impor- 
tation of gold actually prohibited, although newspaper notices might 
lead one to believe the contrary. 

As a result of our great excess of gold imports during 1915 and 1916, 
some of the more serious minded financiers began to question whether 
or not we were having too much gold thrust upon us,” but as the ex- 
cess dwindled to $181,000,000 in 1917 and to $21,000,000 in 1918, and 
then finally turned into excess exports of $291,000,000 in 1919, the 
fear seemed to pass away. In 1920 and 1921, however, the inrushing 
flood of gold again became so great that financiers and economists 
once more raised the inquiry as to the seriousness of the situation. 
In 1921 the Mechanics and Merchants National Bank of New York 


1 This measure as first enacted was to remain effective only until February 4, 1917. It 
was later extended for a longer period. 

2The Annalist of November 13, 10916, editorially remarked that, ‘‘The threat of too 
much gold has come to be looked upon by bankers as one of the practical problems of the 
day.” On November 2, 1916, the New York Journal of Commerce and Commercial Bul- 
letin stated that, ‘“‘ Additional gold importations are neither needed nor desired by American 
bankers.” 


a 


426 DOMESTIC AND FOREIGN EXCHANGE 


in one of its circulars excellently stated the problem in the following 
manner: 


“Paradoxical as it may seem to those who see in the present inward flow 
of gold a powerful influence toward relieving them from the present level 
of money rates, it is not a good thing that so much gold should now be com- 
ing hither from abroad. It does not help matters. On the contrary, America 
having become the gold pivot of the world, it would be far better were 
gold going out to the countries where it is most needed, rather than coming 
from them. Gold accumulation abroad would strengthen currency systems 
and re-establish credit, and would thus contribute to restoring equilibrium 
and stability to the international exchanges. Gold accumulations here, 
on the other hand, in their present rapid pace, simply contribute new ele- 
ments toward a renewal of inflation, and by just the degree in which they 
do that, stand in the way of restoring equilibrium and stability to the 
international exchanges. 

“Tf, therefore, gold imports continue unchecked, the ultimate disturbing 
effect on our domestic banking position and on the international exchanges 
will have to be very seriously considered. It is one of the strange phe- 
nomena of a perplexing situation in world economics that gold should 
now be leaving those markets where it is most needed for the markets 
where it is not needed at all.” 


We have no need of this excess gold; we are unable to use it to ad- 
vantage, and yet its coming has sadly crippled foreign nations that 
could much better employ it. Various plans and programs have been 
suggested (to be discussed in Chapter XIV) to alleviate the situation 
caused by our excess of gold and its scarcity abroad, but at present 
(April, 1922) the accepted policy seems to be to let matters take their 
course, naturally and without the application of artificial means of 
stabilizing exchange rates or of distributing the world’s gold on a more 
satisfactory basis. ‘The future alone will disclose whether or not 
present policies are to be justified. But, so far as our own country 
is concerned, we are still a free gold market, permitting the import 
and export of gold without any restrictions whatsoever. 


CHAPTER XII 


EXCHANGE RELATIONS WITH SILVER, GOLD EXCHANGE, 
AND PAPER STANDARD COUNTRIES 


Thus far we have been dealing with exchange relations between gold 
standard countries. While some of the phases of the discussion may 
have seemed complicated, yet it will be found that the subject be- 
comes increasingly intricate as we consider exchange relations with 
the silver standard, gold exchange standard and paper standard coun- 
tries. 

Before the opening of the roth century, silver played an equally 
important part with gold in the trading activities of all nations, but 
as one by one the leading countries adopted the gold standard and 
closed their mints to the free coinage of silver, the white metal fell 
more and more into disuse as an international medium of exchange 
until today it serves as a legal standard only for China, Indo-China, 
Guatemala, and Honduras. It is hoped that the future may see it 
abandoned even by these four nations. Efforts have been made for 
decades past to accomplish this much needed reform for China, but as 
yet economic and political conditions have not progressed far enough 
to bring it about. 

Before the war, the world’s production of silver averaged between 
220,000,000 and 226,000,000 ounces per year, but in 1914 it dropped 
to 211,000,000 ounces; in 1915 tO 179,000,000; In 1916 to 157,000,000; 
rising to 174,000,000 in 1917, and to 197,000,000 in 1918; but again 
falling to 175,000,000 in 1919, and to an amount estimated at slightly 
less than that in 1920. The United States produces about one-third 
of the world’s output, Mexico slightly more, with South America and 
Canada next in importance. About two-thirds of the silver output 
of our country, however, is incidental to the production of other metals. 

London is the great international market for silver as well as for 
gold, and her price controls the price of silver throughout the world. 
Four large firms dominate the market. Their representatives meet 
daily to fix the price at which the metal shall be purchased from the 
smelting companies. The latter are the most important sellers and 


427 


428 DOMESTIC AND FOREIGN EXCHANGE 


act as agents for the producers. Two prices are quoted, “spot” or 
“ready,” and “forward” or “ future.’”’ The spot price is the price for 
silver which is to be delivered for cash within a week, while the forward 
price is the price for silver to be delivered within two months. No 
forward prices were quoted during the war. ‘Sometimes the Eastern 
exchange banks buy silver merely for covering operations against 
their exchange transactions and dispose of ‘forward’ silver before the 
date of delivery is due. There is also another operation carried on 
called a ‘budlee.’ To budlee silver is to buy ‘ready’ and to sell ‘for- 
ward.’”’! The buyers of silver are the governments that have need 
of the metal for monetary purposes, manufacturers engaged in the 
production of commodities in which silver plays a part, banks con- 
cerned with the financing of trade with silver standard countries, 
and speculators. The brokerage fee on sales, usually 1/8 per cent, is 
borne by the buyer. 

In gold standard countries, the price of gold is fixed in normal times, 
either absolutely, as in the case of the United States, or within fairly 
well defined limits, as in the case of England. Rates of exchange be- 
tween such countries normally fluctuate between the gold export and 
the gold import points, and the returns from exchange operations be- 
tween parties in those countries are therefore capable of being cal- 
culated with a surprising degree of definiteness. The price of silver, 
however, is not fixed, but varies daily in terms of gold. Because of 
that fact, exchange transactions between a gold standard and a silver 
standard country are always highly speculative in character. 

Until 1873, however, the price of silver fluctuated but slightly. 
Since that time, its vagaries of ups and downs, mostly downs, have 
greatly interfered with the trading and financial activities of silver 
standard countries. Taking the quotations of the London market 
(Table XV) as indicative of the trend throughout the world, the 
average yearly price in 1833-1873 fluctuated between the narrow limits 
of 59 3/16d. and 62 1/16d. per standard (0.925) ounce. The average 
yearly quotation then fell gradually with several slight recoveries, un- 
til it reached the extremely low point of 23 5/8d. in 1915. War con- 
ditions, however, brought about an amazing rebound until a new high 
average yearly quotation of 61 13/32d. was reached in 1920. In the 
New York market also silver reached its highest yearly average price 
($1.34649 per fine ounce) that same year. 

1 Spalding, W. F., “Eastern Exchange, Currency and Finance,” 1920 ed., p. 285. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 429 


TABLE XV 


AVERAGE YEARLY QUOTATION OF SILVER PER STANDARD OUNCE IN THE 
LONDON MARKET, 1833-1921 1 


Pence Pence Pence Pence 


1833 59 3/16 1855 61 5/16 1877 54 13/16 1899 27 7/16 
1834 59 15/16 1856 61 5/16 1878 52 9/16 1900 628 « 65/16 


1835 59 11/16 Lone. Ot esa: 1879 5I 1/4 TOOL), 37) ws10 
1836 60 Meet SO) OT STO 1880 52 1/4 1902. 24 1/16 
1837. 59 9/16 7550/0027 91/10 1881 51 11/16 1903. 24 3/4 
1838 59 1/2 1860 61 11/16 1882 51 5/8 1904 26 13/32 


1839 60 3/8 1861 60 13/16 1883 50 9/16 1905 27 13/16 
1840 60 3/8 1862 61 7/16 1884 50 11/16 1906 30 7/8 
1841 60 1/16 1863 61 3/8 1885 48 9/16 1907 30 3/16 


1842 59 7/16 1864 61 3/8 1886 45 3/8 1908 24 13/32 
1843 59 3/16 1865 61 1/16 1887 44 11/16 1000 °23° 23100 
1844 59 1/2 1866 61 1/8 1888 42 7/8 IQIO 24 21/32 
1845 50 1/4 1867 60 9/16 1889 42 11/16 IQII 24 19/32 
1846 59 5/16 1868 60 1/2 1890 47 3/4 O12.) 25), 1/76 
1847 59 11/16 1869 60 7/16 189r 45 1/16 1913 27 9/16 
1848 59 1/2 1870 60 9/16 1892 39 3/4 TOIA 125 4 t/4 


1849 59 3/4 1871 60 1/2 1893 35 9/16 1915 23 5/8 
1850 60 1/16 1872 60 5/16 1894 28 15/16 TOILG alee 
1851 61 18727 50" 3/10 1895 29 13/16 I9QI7 40 13/16 
1852 60 1/2 1874 58 5/16 1896 30 13/16 1918 47 17/32 
Posn) OF 1/2 1975.50 11/10 1897 27 9/16 TOTOT* 371152 
1854 61 1/2 1876 52 3/4 1898 26 15/16 1920 61 13/32 


We cannot concern ourselves with the details of the causes of these 
wide fluctuations, such as the demonetization of silver by the United 
States in 1873, the closing of the Indian Mint to the free coinage of 
silver in 1893, the enactment by the United States of the Bland- 
Allison Law in 1878 and the Sherman Law in 1890 and their subse- 
quent repeals in 1890 and 1893 respectively, the discovery of new 
sources of silver ore, reduced costs of production, silver as a by- 
product of the mining of other metals, etc., etc. One can find such 
data, if desired, in almost any volume dealing with the subject of 
Money. We are interested, however, first in the causes of the vio- 
lent fluctuations during the World War, and second in the question 
as to how variations in the price of silver, either in normal or ab- 


1 Annual Report of the Director of the U. S. Mint, 1921, p. 137. 


430 DOMESTIC AND FOREIGN EXCHANGE 


TABLE XVI 


VALUE OF FINE OUNCE OF SILVER IN NEW YORK AT THE AVERAGE YEARLY 
QUOTATION, BASED ON THE LONDON PRICE CONVERTED AT PAR OF 


EXCHANGE, 1873-1920 ! 


1673.04 71520700 TOGO %). © OS512 1905... 7/0 Oroee 
TATA) el ea oos 1890... .1..04634 1906: son 7ee 
TOPS wd (oars I891I.... .g8800 1907...) sO0nne 
T5702... SL DATA 100g cee 207 Las 1908.... .53490 
1977.,..1.20180 TOO Tae Sy OCAG 1900. /. 7.) s ge0hU 
hey hag ae aed le te TOGA test hOSATO IQIO!....  usaou? 
TOTO. LIne 302 T9055) 40 5400 AIQLIA J. peace 
1880....1.14507 1800.,55- 407505 IQT2.,. eeeOlaeu 
POL hs S290 1897.... .60438 1013.4... .00aSa 
T6602...) 1413502 1898.... .5Q0I0 IOT4. J. a Shane 
1883....1.10874 1899.... .60154 IQS sacs ne See 
1884....1.11068 I900.... .62007 1916... J. |. Od047 
1835). 4%41.005150 IQOT 2.25. 50505 IOL7. .5, voagas 
1886.... .99467 TQO2 2 neas 2704 IOS... Te OAL s 
TOO 7s 745 07040 1003 Ae b4daes? IOIO. <4 11 esOay 
1888.... .93974 LQOO4. ey O70 1920....1.34649 


normal times, affect exchange dealers, exporters, importers, and 
investors. 

During 1914 the price of silver in the London market opened at 
26 7/16d. per standard ounce and closed at 22 3/8d. With the new 
year (1915) the demands of the belligerents for silver began to be felt. 
Gold had disappeared from circulation, being hoarded either by the 
central banks or by the people. England, France, Russia, Italy, and 
other nations began to coin silver in large amounts so as to supply the 
needs of the people for “hard”? money. Troops in strange lands had 
_to have silver coins because of the objections of the natives to paper 
money. The decreased production of the Mexican mines, caused by 
the political conditions in that country, also had a strengthening effect. 
The European nations, together with India and China, remained in 
the market as active buyers with the result that the price of silver rose 
steadily during 1915, closing at about 26d. Shortly after the opening 
of 1916 the price began skyrocketing and reached 38 1/8d. in May, only 
to fall again to about 29d. in July. An astonishing recovery occurred 
and the year closed with the price at about 37d. At that time the 


1 Annual Report of the Director of the U.S. Mint, 1921, p. 137. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 431 


demand for silver was at a point unknown before in history. In the 
latter part of 1916, England, France, Russia, and Italy agreed to 
cease competitive buying and to pool their purchases. England also 
issued an order prohibiting all speculation in silver bullion, hoping 
thus to carry out more effectively the pooling arrangement. The 
price remained stationary for but a short time, and then began a steady 
advance. In April, 1917, we declared war against Germany and were 
immediately faced with the problem of supplying an increased cir- 
culation in order to care for the needs of our people for money with 
which to purchase Liberty Bonds, pay taxes, etc., for corporations to 
handle larger payrolls and buy increasingly greater amounts of sup- 
plies, and for the government itself to pay troops at home and abroad. 
In 1916 China had disposed of a large amount of her surplus silver to 
India and Russia at prices that, at the time, were considered most 
satisfactory. In 1917, however, she found herself forced into the 
market to replenish her stock, and purchased heavily from the United 
States. In June, 10917, silver was selling in London at 39d., and in 
July at 41d. England thereupon announced an embargo on imports 
of silver into India, her purpose being a more effective control of the 
market. But in the face of the prevailing economic conditions, Eng- 
land found herself powerless to regulate the price. In August it again 
advanced. By September 14, it had reached the high point for that 
year, 55d., the increase being due principally to the demands of China. 
At the price of 55d. the rupee of India was worth more as bullion than 
as a coin, and the natives began hoarding rupees or melting them down 
for export. England then raised the exchange value of the rupee from 
1s. 4d. to 1s. 5d. and issued an order prohibiting the export of silver 
coin or bullion from India. England likewise prohibited the export 
of silver from England to neutral countries except under license. The 
New York Journal of Commerce and Commercial Bulletin of Septem- 
ber 19, 1917, gave the following as the most outstanding causes for 
the then existing high price of silver: 


“Extreme scarcity and worldwide demand. 

“Withdrawal of gold from circulation in Europe and Oriental countries. 

“United States, Great Britain, France, Russia and Italy have been 
obliged to make heavy purchases for subsidiary coinage to pay their troops. 
China, Japan and India have also been large buyers. 

“Shortage of cyanide, which ordinarily sells at 14¢, now quoted at $3.25 
per pound, with only limited amount available. If scarcity continues, some 


432 DOMESTIC AND FOREIGN EXCHANGE 


authorities assert, the old fashioned method could be reverted to, such as 
mechanical concentration. 

“Tncreased freight and insurance rates and higher mining costs. In 
time of peace the cost of shipping metal to London is 4%¢ per ounce, To- 
day it is 8!4¢ per ounce. 

“Hoarding of metal by plain people of various countries abroad. 

“Curtailment of output of silver in Mexico. 

“Silversmiths in market for bullion to prepare for the Christmas season.” 


The market eased off during the latter part of 1917 and closed at 
43 44d. In November, Great Britain entered into an agreement with 
the United States whereby both agreed to purchase a total of 100,000- 
ooo ounces of silver in the American market during 1918. Both 
countries asked the silver merchants and purchasers to aid them in 
obtaining the metal as cheaply as possible. On December 5, our news- 
papers contained an announcement to the effect that “The Govern- 
ment will take over the country’s silver output and will fix the price.” 
Conferences were held with silver merchants and producers but with 
no results. Silver rose slightly in January, 1918, fell off in February, 
and in March commenced what appeared to be a consistently upward 
movement, reaching 45 5/8d. on March 29. On April 25 the President 
of the United States signed the Pittman Bill. We had been purchasing 
raw materials in large quantities from China and India. We disliked 
to pay in gold inasmuch as at that time we were doing all within our 
power to conserve our gold holdings. We finally arrived at the happy 
idea of paying India and China out of the large supply of silver dollars 
which our Treasury had stored away as security for the outstanding 
silver certificates. The natives of India at that time were in a state of 
unrest, which was further heightened by the efforts of the British 
government to force paper money into circulation in that country. 
To pay India in silver, therefore, would not only be conserving our 
own gold supply, but would also be assisting our ally to maintain 
peace within one of its most important possessions. The Pittman Act, 
in brief, authorized the Secretary of the Treasury to melt and sell as 
bullion not over 350,000,000 standard silver dollars, then being held 
as security behind the silver certificates, and to sell the bullion thus 
obtained at not less than $1.00 per ounce 1000 fine. In order to avoid 
the disadvantages of a possible contraction of our currency, the Federal 
Reserve banks were permitted to issue an amount of Federal Reserve 
bank notes not to exceed the amount of silver certificates retired, 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 433 


these notes to be secured by United States certificates of indebted- 
ness or United States one year gold notes. In allocating the silver 
thus obtained, the needs of our government and of our allies were given 
preference, although shipments were later permitted for commercial 
purposes. Up to May 6, 1919, the date of the final transaction, 260,- 
121,554 silver dollars had been melted down under the provisions of 
the Act for use in foreign trade,! and up to December 31, 1910, $259,- 
375,000 of Federal Reserve bank notes had been issued. 

On August 9, 1918, the British Treasury fixed the maximum price 
of silver at 48 13/16d. per standard ounce. On August 20 it was com- 
pelled to raise this maximum price to 49!4d., following the action of 
the United States government on August 16 in fixing the price of 
silver in New York at $1.0114. The export of the precious metals from 
the United States was absolutely controlled through the Federal Re- 
serve Board and no licenses for export were given at that time. On 
November 13 the British Treasury fixed its maximum price at 48 3/ad., 
on December 6 at 47 7/16d., on February 11, 1919, at 47 7/8d., and 
on February 20, at 47 3/ad., the market price being the same as that 
fixed by the Treasury.” These changes were made because of the de- 
crease in freight and insurance rates on shipments from the United 
States. 

In March, 1919, England “un-pegged”’ her exchange, and sterling 
immediately fell away from 4.76, where it had been most skilfully held 
for several years. Thereupon it became necessary for the English 
government to readjust its maximum price of silver because thence- 
forth not only would the London price have to be calculated on the 
basis of the New York price plus shipping costs, but also on the addi- 
tional factor of the cross-rate of exchange (the sterling rate in New 
York). The price fixed by England was 95¢ per ounce at the current 
rate of sterling exchange in New York. Thus if sterling exchange in 
New York fell, and if shipping costs remained the same, the price of 


1 10,000,000 silver dollars were also melted down between December 5, 1919, and March 
22, 1920, to provide our government with silver for subsidiary coinage purposes. 

2 “Owing to the restrictions imposed upon the transit of silver, quotations abroad have 
shown little relation to those ruling in this market, as will be seen below: 


France: i%t cave scan March 3, 1919 49 1/16d. 
EN One eee 6 60 13/16d. 

Spain secret ts 8 54 5/8 

Sweden verntaas vets 24 60 

DGS ele e cere s+. 23 51 9/16 

London, on all above dates mentioned 47 3/4d.” 


London Economist, April 26, r919. 


434 DOMESTIC AND FOREIGN EXCHANGE 


silver in London would rise, and vice versa. Silver immediately rose 
to sod. on March 28, but eased off during April, ranging between 
48 g/tod. and 48 15/16d. during that month. On May 5 the United 
States announced that it had abandoned its control of the American 
silver market. On May 9g, the British Treasury did likewise. Inti- 
mation was subsequently given by the British Treasury that “licenses 
would be granted freely for export. The immediate effect upon the 
market, which had been ina state of suspended animation for several 
months, was very great. No available stock of silver existed from 
which continental demands could be supplied. As a consequence the 
price moved at a speed absolutely without precedent. It leaped in one 
bound on the oth from 48 5/8d. to 5314d. On the roth, 58d. for cash 
delivery. . . .” | which was the record since January, 1877. In June 
and in early July, it dropped slightly but again advanced step by step 
until it reached the amazing figure of 79 1/8d. on December 16. On 
November 25 silver had sold in New York at the record price of 
$1.3814 per fine ounce. It is said that some sales were consummated 
in San Francisco at $1.42. Our exchanges and our trade relations 
with silver standard countries were seriously menaced, not to mention 
the possibility of subsidiary coinage being taken from circulation, 
melted, and exported as bullion in order to pay our existing adverse 
trade balance with Oriental countries. On December 6 an announce- 
ment was made that, under arrangements between the United States 
Treasury and the Federal Reserve Board, the “free” silver dollars in 
the Treasury * would be delivered against any other forms of money 
to the Division of Foreign Exchange of the Federal Reserve Board, 
which would, acting through the Federal Reserve Bank of New York 
in codperation with the branches of American banks in the Orient, 
employ such dollars in regulating our exchanges with silver standard 
countries. About $13,000,000 of silver was shipped to Shanghai 
under this arrangement during the early months of 1920. The sudden 
decline in the price of silver which occurred within a few months made 
further shipments unnecessary. 

During the opening weeks of 1920 silver continued to rise and in 
London reached the record price of 89%4d. on February 11. India, 
China, and Japan had been starved for silver during the World War. 
When the market opened they rushed in and, bidding against each 


1 London Economist, May 17, 1919. 
2 Silver dollars not used as security for silver certificates. 


—— — 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 435 


other, forced the price upward to record levels. After the highest 
point had been reached in February, the market eased off rapidly 
and closed at 40 7/8d. on December 31. The startling rise in the Lon- 
don price of silver was due primarily to the collapse of sterling ex- 
change in the American market. With every fall in the sterling rate 
the cost of procuring silver in the United States rose and the price of 
silver in London advanced accordingly. Thus silver at $1 per ounce 
1000 fine in New York when converted at par ($4.8665 = £1) is worth 
45l4d. per standard (0.925) ounce in London. If sterling exchange 
falls to a discount of 28 per cent, silver at $1 per fine ounce in New 
York is then worth 63d. per standard ounce in London since it takes 
more sterling exchange to buy the same amount of silver. Thus the 
cross-rate (New York on London) was the dominating factor in the 
situation so far as the London price was concerned. In reality, during 
the war and down to the present time (April, 1922) New York has been 
the most important silver market in the world. When the United 
States government fixed the price of silver, England followed our lead 
and did likewise, fixing her price on our basis. When we abandoned 
official control over the silver market, so did England; and when we 
established a completely free market for silver, the English price fluc- 
tuated almost always in unison with the price of foreign silver in the 
New York market converted at the current rate of sterling exchange 
plus shipping costs. In face of these facts, it is not at all surprising 
that many Americans thought that there might be a possibility of 
New York displacing London as the world’s silver market. But here 
again, as has been true in other connections, we had neither the fore- 
sight nor the leadership to capitalize our war-time advantages into 
permanent supremacy. Even today, in spite of the London silver 
quotation being based upon that of New York, London is considered 
as the world’s silver center, and will undoubtedly remain so for many 
years to come. 

But to resume the story of silver after the war: By May, 1920, 
silver in the United States had dropped below $1 per fine ounce, which 
was the minimum price provided by the Pittman Act for the re-pur- 
chase of government supplies to replace the silver dollars melted 
under the authority of that Act. The Treasury immediately entered 
the market as a purchaser at $1 per ounce tooo fine. “The Act pro- 
vided that the silver purchased should be of American origin and re- 
fined in the United States. The Treasury, however, placed a liberal 


436 DOMESTIC AND FOREIGN EXCHANGE 


interpretation on this clause to the effect that individual silver need 
not be identified so long as each producer should sell as American 
silver that portion of his silver product which corresponded to the 
silver mined and refined in this country.” + An agreement was en- 
tered into between the Treasury and the producers whereby the latter 
were to receive 99 5/8¢ per ounce 999 fine. The price since that time 
has fluctuated around 99 5/8¢, sometimes reaching 99 3/4¢, and at 
other times falling to 99 1/4¢. Up to July 25, 1921, about one-third of 
the total amount required to replace the melted silver dollars had been 
obtained, and it is now thought that the United States Treasury will 
be in the market as a purchaser of domestic silver at the fixed price 
until at least 1923. These purchases by the United States govern- 
ment and the absence of American silver from the world market tended 
almost immediately to have a slight temporary stabilizing effect upon 
the price of silver in London, but other factors soon appeared, chiefly 
the lack of demand by India and China and the increasing supplies 
from Mexican sources, with the result that the price of silver continued 
its downward course. On March 5, 1921, the low mark for the year 
was reached at 30 5/8d. There was a noticeable recovery during sub- 
sequent months, and on September 20, the high mark for the year was 
reached at 43 7/8d. the controlling influence being the appearance of 
China and India in the market as heavy buyers. The year closed with 
silver at 34 5/8d. Since that time (to April, 1922) the price in the 
London market has continued to fluctuate around 34d. per ounce. 

In the New York market as well, the price of foreign silver has 
fallen to lower levels, reaching 53!4¢ on March 5, 1921. This situation 
has inevitably produced a vigorous discussion in certain circles as to 
the wisdom of the requirement of the Pittman Law that the Treasury 
must purchase domestic silver at not less than $1 per fine ounce re- 
gardless of the market price of foreign silver. For example, when 
foreign silver was selling in New York at, say, 60o¢ per ounce, 
as it did on February 17, 1921, the American government was 
paying 99'4¢ for domestic silver, in other words, actually giving 
a bonus of 3914¢ to American producers. The total excess cost of 
silver to the United States government over what it would have had 
to pay if it had not been restricted by the Pittman Act to the 
minimum price of $1 per fine ounce, will approximate millions of 
dollars. 

1 Federal Reserve Bulletin, August, 1921, p. 935. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 437 


Tables XV! and XVI? and Charts VII and VIII ® tell the story 
of the fluctuations in the price of silver. Chart VII is especially in- 
teresting as showing the striking similarity in the trend of the New 
York price of foreign silver and wholesale prices in the United States 
from November, 1918, to February, 1922. Such similarity does not 
appear in the early history of silver and may not appear again in future 





| Fut 
| | fommme PRICE OF SILVER. 
|} | WHOLESALE PRICE INDI 












ocd Bethe a eX ey ee ya 
Cuart VII 
Prices of silver in the United States and wholesale price 
index, November, 1918—April, 1922 (per cent of 1913 
averages). Adapted from Federgl Reserve Bulletin, 
August, 1921, p. 937, and extended to date. 





years. This strange coincidence is undoubtedly explained by the fact 
that for the time being, owing to the scarcity of the supply and the 
strength of the demand, the price of silver was subject to the same 
economic forces that were governing the prices of other commodities 
and responded accordingly. 

The unparalleled advance in the price of silver during 1916-20 had 


1P, 420. 2P. 430. 3 P. 443. 


438 DOMESTIC AND FOREIGN EXCHANGE 


some surprising effects upon the monetary systems of certain coun- 
tries. As silver rose it became evident that silver coins would inevi- 
tably be worth more as bullion than as money, with the consequent 
danger of their being taken from circulation and hoarded or melted 
up and exported. The melting points of the silver coins of the more 
important countries are shown in the following table: 


TABLE XVII 
MELTING PoINTs OF SILVER CURRENCIES ! 


Melting Point (Price of Silver per Ounce) 
In U. S. Money 


At June, 


Fine Silver 
At Par of | 1921, 


Coin i ontent In Local Currency Eechanee \eRagee 
rains) 
Exchange 
Dollar} 4sct ce a: 371.25 1.2929 Gollars) 9]. .:-4.90 ee 
Subsidiary silver 
(dime) fers aaae 34.722 1.3824 dollars’ || 2... 30 a eee 
Shilling: 
Qld ator ne 80.7263 5.946 shillings $1 .447 $x .124 
INEWr ea totea ee 43.6364 11 shillings 2.677 2.08 
erfrancG Piece aia bis 374.22 7.234 francs 1.3096 584 
t-frane piece. Poy 2. 64.4286 7.45 francs I.438 .602 
DEAK eis ea age II.16 6.221 marks 1.482 09 
Dray ve ee cad 2s 64.4286 7.45 lire T.438 a, i 4 


From November, 1919, to February, 1920, the price of silver was 
above the melting point for our silver dollar, although not for our 
subsidiary coins. It was for the purpose of trying to prevent a possible 
rise of silver to $1.3824 and thus to protect our subsidiary coinage 
from export, that the Federal Reserve Board and the Treasury co- 
operated with American banks having branches in the Orient in using 
the free silver dollars in our Treasury for the payment of our adverse 
Oriental trade balance, as has been noted above. In January, 1920, 
the old shilling of Great Britain became worth less as money than as 
bullion, and a new shilling of 500/1o0o fineness (the former shilling 

1 Federal Reserve Bulletin, August, 1921, p. 936. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 439 


had been of 925/1000 fineness) was issued to forestall the danger that 
the shilling might be melted down. For the same reason Great Britain 
was compelled to change the value of the Indian rupee five different 
times between 1917 and 1919, advancing it from ts. 4d. in 1917 to 2s. 
on September 10, t919.1 Norway, Sweden, Holland, and other coun- 
tries took similar measures to protect their coinage. ‘The silver 5-franc 
pieces of France, because of their greater bullion value, were smuggled 
in large quantities into Switzerland, where they had two or three times 
the purchasing power that they had at home. Switzerland, acting 
at the request of France, finally declared them no longer to be legal 
tender within Swiss territory, thus making their return to France 
more probable. Silver disappeared from circulation in Germany and 
Italy. Germany, with a supply of silver coins in her central bank, 
melted them and threw the bullion on the market at the prevailing 
high price for silver, as did several other continental nations. The 
unique factor that entered into the situation was the effect of the New 
York cross-rate upon the melting point of the silver coins of these 
countries. It will be noted from Table XVII above that, with ex- 
change at par, the melting point was considerably higher than with 
exchange at the rates prevailing in June, 1921. Primarily because 
of the large amounts of depreciated paper money issued by foreign 
countries, exchange rates at that time were greatly below par, the 
extent of depreciation of their paper money being roughly measured 
by the discount at which their exchange stood in our country. Con- 
versely, both gold and silver coins were at a premium as measured in 
terms of the paper money of those countries. The prices at which those 
coins could be profitably melted down on the basis of the value of 
their metallic content was therefore lower than if exchange had been 
at par, or if there had been no premium on the money metal. Thus, 
where nominally the silver in the mark is worth a mark when silver 
in the market sells at 6.2221 marks per ounce (or $1.482 when con- 
verted at the par of one mark = $.238), yet with the New York mark 
quotation at, say, .o13, or approximately 1/18 of what it normally is, 
the melting point of the mark is reached when silver is worth as little 
as 8¢ an ounce. As exchange rates on continental countries rise 
to normal and the premium on gold and silver coins disappears, the 


1A subsequent section of this chapter will be devoted to a discussion of the changes 
made necessary in the gold exchange standard of India by the unparalleled fluctuations 
in the price of silver. 


440 DOMESTIC AND FOREIGN EXCHANGE 


melting point of foreign silver coins will likewise revert to nor- 
mal. 

With but a few exceptional years, the United States has always been 
a heavy exporter of silver, and the story of the period from August, 
1914, to December 31, 1921, is no exception to the rule. The seemingly 
surprising thing is that the movement of silver should have been so 
strongly in contrast to that of gold in the face of our extremely large 
favorable balance of trade. The year 1921 alone shows an excess of 


TABLE XVIII 
SILVER IMPORTS INTO AND EXPORTS FROM THE UNITED STATES 


Imports Exports Excess Exports 
August I, 1914 to December STi: TOld). Wiese 12,129,000 22,182,000 10,053,000 
January t.1015- Sl, IOLS. esi eh 34,484,000 53,599,000 19,115,000 
rT; 1916 Ee 5 Sit 1OL0se45 oe 32,263,000 70,595,000 38,332,000 
ae hes Sh LOTT Sa INST, TOLT ee on 53,340,000 84,131,000 30,791,000 
eee SOLS ore os ST MOLo tae he 71,370,000 252,846,000 181,470,000 
aT DR Tey fe tags ms CN Pt (ay ts Peed dM 89,410,000 239,021,000 149,611,000 
sry weet, <kDSO) os ? 31; 20270).4.55 88,060,000 113,616,000 25,550,000 
Tine Oates 4 ST, 8027. Gens 63,242,000 51,575,000 11,667,000 1 
Ota bcos 5 Gite aa wae sin. ct ein Se meaty ck ee ee 444,304,000 887,565,000 443,201,000 


1 Excess of imports. 


imports over exports. In that year $41,250,000, or two-thirds of our 
total silver imports came from Mexico, while $7,088,000 came largely 
from Germany and Great Britain. Over 80 per cent of our silver ex- 
ports during that year went to the Orient and to Great Britain,—those 
going to Great Britain being presumably for India. 

During the War practically every nation either prohibited the ex- 
port of silver or permitted it only under license from some govern- 
mental body. Even at this writing, many of those regulations still per- 
sist. Export of silver in any form is prohibited in Hungary, Jugo- 
Slavia, Poland, Roumania, Sweden, Turkey, and Syria, while the ex- 
port of silver coin only is prohibited in Spain and Mexico. Export 
is permitted under license in Austria, Chile, Cuba, Japan, Belgium, 
Bulgaria, Czecho-Slovakia, Denmark, Finland, France, Great Britain, 
Greece, Italy, Luxemburg, New Zealand, Norway, South Africa and 
Switzerland.! 

A. SILVER STANDARD 


China is the only important silver standard country in the world. 
There is not need to discuss the efforts that have been made in the past 


1 Compiled from the Weekly Review of Foreign Exchanges issued by Samuel Montagu 
and Company of London. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 441 


to induce her to adopt either the gold standard or the gold exchange 
standard.! Those efforts have been of no avail, and as a result China 
stands alone as “the Paradise of the Money Changer.” 

“The currency situation of China has always been confused because 
of the non-existence of a uniform currency system. The present unit 
of currency is the tael or Liang. This is not a coin, but a measure of 
value. It is supposed to weigh an ounce of pure silver, but there is no 
fixity about this unit for it varies both in weight and value in the differ- 
ent cities and provinces of the empire. The only actual money coin 
is the so-called copper cash. It has been used in China for more than 
three thousand years. Its value as money is figured as the one thou- 
sandth part of a tael, but in reality it has deteriorated and its price 
varies according to the demand. Its copper contents have been 
greatly reduced by the provincial authorities who are responsible 
for its coinage, and the Chinese will accept it only as an approximate 
of its intrinsic value. Cash is a flat oval coin, with a square hole in 
the center for the purpose of stringing large quantities of them to- 
gether, a knot being tied at each 100 coins in order to facilitate calcu- 
lation. For commercial transactions on a large scale, a monetary 
unit so small as the cash would not be practicable. Therefore, all 
payments of consequence are made in silver bullion called sycee (silver 
ingots of different sizes, ordinarily worth about 50 tael), based on a 
money table of 10 cash equal one candareen, 10 candareen equal one 
mace, 10 mace equal one tael (both the mace and the candareen are 
also measures of value and not coins). From a fancied resemblance 
to the shape of a Chinese woman’s foot, these ingots have come to be 
called shoes. Although they are the principal element in the monetary 
circulation of China, the Government has no hand in their creation, 
the issue of them being left to the bankers and money changers who 
cast them, according to their own standards of fineness. There are 
some ten varieties of Chinese dollars, in addition to the Hongkong 
or local currency dollar, the Straits dollar, the Mexican dollar (old 
die) and the old Spanish dollar.” ? 

In 1914, the Chinese government issued the Yuan dollar and de- 
clared that henceforth it was to be the unit of Chinese currency. Since 

1Cf. especially two reports by the Commission on International Exchange, dealing 
with “Introduction of the Gold Exchange Standard into China, the Philippine Islands, 
Panama, and Other Silver Using Countries,” one of which was submitted to our Secretary 


of State on October 1, 1903, and the other to Congress on January 26, 1905. 
2 Curran, John S., Bulletin of the American Institute of Banking, July, 1921, p. 360. 


442 DOMESTIC AND FOREIGN EXCHANGE 


then it has been gradually supplanting the Mexican dollar in the 
internal trade of China. The Chinese have a unique practice of pre- 
ferring a “chopped” dollar to a “clean” dollar. The chopped dollar 
is one upon which a native exchange dealer has stamped his particular 
mark or “chop,” guaranteeing that the coin is what it purports to be. 
Each time a dealer puts his chop on a dollar, a small portion of its 
silver content is removed. Clean dollars do not circulate. They are 
bought and sold for their commodity value as silver. 

Nearly every important town in China has its own tael, differing 
from the others in weight and fineness, but usually approximating 
t 1/3 oz. avoirdupois pure silver. More than 170 different taels are 
known to be in circulation. The four most important, however, are: 
first, the Haikwan tael of 583.3 grains of pure silver, used by the 
Chinese government as the basis for the collection of customs duties; 
second, the Kuping tael of about 573.865 grains of pure silver, formerly 
used exclusively, now only partly, by the government in its collection 
of internal revenues; third, the Shanghai or Tsao-ping tael, of about 
545.25 grains of silver, 980 fine, used by banks in Shanghai in quoting 
exchange rates; and, fourth, the Canton tael of 579.85 grains pure 
silver, employed mostly in the Canton province. The Chinese Repub- 
lic has attempted to bring uniformity out of chaos by adopting a dollar 
practically equivalent in weight and fineness to the Mexican dollar, 
and has used it in payment of salaries, budget matters, and for various 
official purposes. Confusion still reigns supreme, however, and will 
continue to do so until, with the passage of time and the introduction 
of monetary reforms, Chinese money becomes standardized throughout 
the republic. 

The value of the dollar or the tael, no matter what particular kind 
it may happen to be, varies daily, although not exactly, with the price 
of silver in the market. It is not possible for us, therefore, to speak 
of “silver points” in dealing with the exchanges of silver standard 
countries as we have spoken of the “gold points” in connection with 
the exchanges of gold standard countries. The export and the im- 
port of silver depend upon its market price in terms of gold, plus its 
cost of shipment. Of course, between two silver standard countries, 
one may conceive of the theoretical existence of silver points (par of 
exchange plus or minus shipping costs) but the term is never employed 
in a discussion of the silver exchanges. Silver does, however, have a 
“shipping point” or a point at which it pays exchange dealers to ship 


—————— ee 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 443 


it into or out of a country. If, because of an increase in exchange 
rates, bankers find that their obligations can be more cheaply met by 
an export of silver, or if because of a decrease in the rates of exchange 
they find that it will profit them to import silver, then silver shipments 


eee tt Ct 
ft SeeEeeaee ieee 



















CEE EEE eat 
Uh 
aameee Miaatae ie 
ee ttt 








: 4 ls 


= = eS suiagt-9 aeeamna 


CuHart VIII 


London quotations of telegraphic transfers, Shanghai, Hongkong, and 
Calcutta, and of price for spot silver, IQI4-1921 


occur. The shipping points, i. e., the rate of exchange at which silver 
may be profitably imported or exported, are not approximately fixed 
because of the constant fluctuations in the price of silver. 


444 DOMESTIC AND FOREIGN EXCHANGE 


The external trade of China and the investment of foreign funds 
in that country have been seriously handicapped because exchange 
on Chinese centers rises and falls, although not always proportionately, 
with the price of silver. This is graphically illustrated by Chart VIII. 

During the last few years Chinese exchange has fluctuated much 
more widely than usual because of the extreme variations in the price 
of silver. A rise or fall of from six to ten points per day per tael or 
Chinese dollar has not been unknown. The following table, condensed 
from a statement appearing in the China Year Book for 1921-221 
gives an idea of the extent of the annual fluctuations in the Shanghai 
tael rate as based on the banks’ selling rate for London telegraphic 
transfers during 1909-20, inclusive: 


TABLE XIX 
OFFICIAL QUOTATIONS SHANGHAI BANKS’ SELLING RATE FOR LONDON T. T. 


Percentage of 
Sl LSA eet aii Average T. T. | Fluctuation to 


hoes Resi Rate on London | Average Yearly 
During the Year : 
Quotation 

TOC J hws sae ee T° 3jad: 2/3 7/8 6.2 
TOI Cees Sears 3 1/8 2/ANCTSILG 10.8 
EQT Ly vive ste ce elke r vOl1b 2/4)) 15/16 5-4 
FOLO Taree ea nes 4 5/8 2/8 5/8 14.1 
TOUS Oih ag a igs 315/16 2/8 1/12 12.3 
TOTAAL eas aga 2/5 3/8 19.6 
TOUS earch sin savers 5 2/3 7/8 17.3 
BOLO sas ae ete 1r 7/8 SIT Titty LO 43.3 
TOSF Coie sae Gs cree is,. 7 2/10 =. 3/8 Lys. 
EOLOMMES dad aiat 15... 2051/2 4/8 11/16 29.1 
OVO ee nlie eee ce 38. 4 5/7 7/8 58.9 
TO20) Pras he ee a 5S. 4 6/1 7/16 87.1 





The phenomenal rise in the average yearly quotation of the Shanghai 
tael from 2s. 3 7/8d. in 1909 to 6s. 1 7/16d. in 1920, indicated that in 
1920 the tael was worth almost three times what it was in 1909. Such 
an astounding increase in the value of the currency of any country 
as measured in terms of the moneys of other nations has seldom been 
known in the annals of exchange transactions. 

1 Pp. 322-3. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 445 


Inasmuch as there is no par of exchange which can be used as a 
basis of comparison, we have in the fourth column of the table given 
the percentage which the yearly range of the quotation bears to the 
average yearly rate. Inspection of this column shows that during 
the normal years of 1909-13, the percentage of fluctuation ranged 
from five to fourteen per cent while during the abnormal years of the 
war and down to 1920, it ranged from 17 to 87 per cent. Similar 
fluctuations were experienced by the other Chinese exchanges. 

So long as silver rises in price and exchange rates follow its upward 
trend, just so long is the Chinese importer at an advantage. Rising 
exchange rates encourage imports and enable the Chinese to pay their 
foreign obligations more easily than they could under other conditions. 
During the last few years of high silver and resulting high exchange 
rates on China, the Chinese have been able to meet their foreign obli- 
gations, of both private and government character, to a decided ad- 
vantage. Chinese exporters, however, have been greatly handicapped, 
_ because the high exchange rate (the decreased purchasing power of 
foreign money as measured in Chinese money) compelled the importers 
in foreign countries to pay high prices for Chinese products, a situation 
that resulted in curtailed exports. On the other hand, during the long 
period of falling silver prices and adverse exchange rates before the 
World War, Chinese exporters prospered, because the money of foreign 
countries, being worth more in terms of Chinese money, would buy 
more goods. The Chinese import trade, however, was hard hit, and 
so was the government, because the low rates of Chinese exchange 
i. e., lessened purchasing power, meant that the Chinese importers 
had to pay higher prices for their goods, and that the Chinese govern- 
ment had to expend larger sums to meet its foreign obligations. 

The constant fluctuation in both the foreign and domestic exchange 
rates in China, even in normal times, has built up a group of exchange 
dealers whose like cannot be found in any other country. A commis- 
sion of 1/8 per cent is charged the seller on ordinary transactions. 
Sometimes huge profits are made by the larger dealers as the result 
of their exchange operations. One of the more important Chinese 
banks is quoted as having cleared about $20,000,000 during 1918-19 
on its exchange business. 

Shipments of goods may be made into China either on the basis of 
the money of the exporter’s country (foreign money) or on the basis 
of the money of the importer’s country (Chinese taels or dollars). If 


446 DOMESTIC AND FOREIGN EXCHANGE 


the foreign exporter selling his goods to a Chinese firm desires to 
protect himself against an adverse fluctuation in the exchange rate, 
he will quote his prices and draw his draft in terms of the money of 
his own country, say American dollars, thus guaranteeing the receipt 
of a definite sum of the money of his own country. Under such cir- 
cumstances the Chinese importer has to assume the risks of exchange. 
If the rate of exchange in China on the United States should rise, that 
is, if the tael or the Chinese dollar should buy more American dollars, 
then the importer will have to pay less for his goods, i. e., he will have 
to give fewer taels or Chinese dollars to the bank in order to obtain a 
sufficient number of American dollars with which to pay his indebted- 
ness. On the other hand, if the American exchange quotation should 
fall, that is, if the tael or Chinese dollar should purchase a smaller 
number of American dollars, the importer will have to give more taels 
or Chinese dollars in order to pay the American dollar draft which 
has been drawn on him. To guard against a possible decrease in the 
exchange rate, it Is customary, although expensive, for the Chinese 
importer to arrange with a banker for “forward exchange” (a “fu- 
ture”) so as to have a definite basis upon which to calculate his ex- 
change payments, and also the cost of his goods. Under a future 
contract, the banker agrees to furnish the Chinese importer with a 
sufficient amount of the needed exchange at the time when the draft 
covering the importation falls due. From the above it is clear that 
if the American exporter draws a draft on the Chinese importer in 
terms of dollars and sells it to his American banker, he (the exporter) 
will receive dollars for it and will not need to bother further about 
fluctuations in the Chinese exchange rate. On the other hand, if he 
draws his draft in terms of dollars and sends it to China for collec- 
tion, he will necessarily run the risk of adverse exchange fluctu- 
ations. The Chinese importer will pay taels or Chinese dollars to the 
Chinese banker and when the sum is remitted to the American ex- 
porter, he may find that the Chinese exchange rate has moved against 
him and that he will receive fewer dollars than he had calculated upon. 
Practically all goods are shipped from the United States to China 
under letters of credit or authorities to purchase, the drafts being 
drawn in dollars and bearing the “interest clause,’ thus removing, 
so far as the American exporters and bankers are concerned, all un- 
certainty as to the returns on the transaction. 

If the American exporter quotes his prices to the Chinese importer 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 447 


in terms of taels or Chinese dollars, and if when a few months later 
he draws his draft in Chinese money exchange rates have moved 
against him, he may lose on the transaction. Say that an American 
firm ships goods to China, billed at 10,000 taels for which a return of 
$7,000 is expected, the rate on Shanghai at that time being 7o¢ per 
tael. The goods reach China, and are paid for by the importer, who 
deposits 10,000 taels with the exporter’s bank as directed. If in the 
meantime, as a result of a decline in the price of silver, the tael falls to 
6614¢, a decrease of 5 per cent, the American firm will actually re- 
ceive 5 per cent less than expected, as it would soon discover should 
it ask to have the 10,000 taels remitted to the United States, for it 
would receive only $6,650 for the taels instead of the expected $7,000. 
The Chinese importing firm, would, under the circumstances, pay 10,000 
taels for the goods, regardless of the position of the exchanges, and would 
therefore bear none of the risks of exchange. Had the transaction 
been financed in dollars instead of in taels, the decreased rate on taels 
would have compelled the Chinaman to pay more for his goods. 

Investors have always been deterred from placing their funds at the 
disposal of Chinese enterprises because they can never be certain of 
the returns thereon nor can they know definitely how much their 
principal will be worth if at any time they see fit to withdraw it from 
investment in China. If the investment yields an interest payable 
in the money of the investor’s country, then, of course, variations in 
the rate of exchange need not be feared; but if the return is payable 
in terms of Chinese money the foreign investor has to assume the risks 
of exchange. If, after a year or so, the investor wishes to withdraw 
his funds, he runs the chance of losing a portion thereof because of an 
adverse exchange rate. As between gold countries, there is, of course, a 
slight fluctuation in the exchange rates that every investor must take 
into consideration, but in normal times such fluctuations are very 
slight. As between a gold standard and a silver standard country, 
the price of silver in the London market is the basis for the position 
of the exchanges. Fluctuations in the price of silver are not possible 
of approximation, hence an element of uncertainty enters into and 
interferes with the investment of foreign funds in silver standard 
countries. 

From the foregoing remarks it is evident that exchange dealings 
with silver standard countries necessitate far more care and attention 
than do transactions between gold standard countries. The price of 


448 DOMESTIC AND FOREIGN EXCHANGE 


silver may change rapidly, as it did during and after the war, causing 
wide variations in the silver exchanges. China is far away; mails are 
slow and cables are expensive, thus making it difficult to transact 
business with the facility and cheapness that characterize our dealings 
with European nations. 

The greater part of the drafts sold on China are for small amounts. 
Cables are seldom sold because the costs are so great. A banker ina 
day’s time may sell ten or a dozen drafts ranging from $10 to $50, with 
only one or two for larger sums, so that it does not pay him to cable 
an advice to his Chinese correspondent concerning each of these sales. 
He usually does one of two things: He may sell a draft to the customer 
at a rate high enough to protect himself against any loss that may be 
occasioned by a rise in the rate caused by an increase in the price of 
silver during the next thirty days and before the draft is presented to 
his Chinese correspondent for payment. Or he may decide at the 
close of the day that he has sold enough of these small amounts of ex- 
change to warrant the sending of a cable advice to the Chinese corre- 
spondent advising him if necessary to purchase enough cover (this 
is necessary when the draft has been drawn in Mexican currency) 
to meet the drafts when presented. “When the latter procedure is 
followed, the accounts at both ends practically balance within twelve 
hours. A cable sent from here in the late afternoon is delivered the 
next morning in China. The silver rate in China on a given morning 
is usually the same as the quotation in New York and London the day 
before. The agent and the seller have nothing to worry about for the 
ensuing month, as far as the particular day’s dealings are concerned, 
because, however silver may move in the interim, both ends are pro- 
tected:7s* 

While it is not possible within the limits of this volume to deal with 
the intricacies of Chinese exchange, either foreign or domestic,’ 
nevertheless it is well for the student of the exchanges to know the 
method followed in arriving at what is called the “parity of exchange,” 
or in other words, the basis for telegraphic transfers between London 
and Shanghai and between New York and Shanghai.® 


1 Annalist, September 18, 1916. 

2 The student will find much of value in this connection in Spaulding, W. F., ‘‘ Eastern 
Exchange, Currency and Finance,” Chapters 20-24; Arnold, J., ‘‘ Commercial Handbook 
of China,” (U. S. Department of Commerce, Bureau of Foreign and Domestic Commerce, 
Vol. 84), Vol. 2, pp. 175-104. 

3 The following discussion of New York and London silver parities is based on Arnold 
op. cit., Vol. 2, pp. 185-188. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 449 


Bar silver is quoted in London at 980.5 fine (that is, 19.5 parts of 
alloy to 980.5 parts of pure silver), while in Shanghai it is quoted at 
998 fine. In normal times, the charges for the shipment of a Shang- 
hai tael between London and Shanghai fluctuate between 8/10 per 
cent and one per cent. These charges are approximately as follows: 
freight, about one-half of one per cent; insurance, one-sixth of one per 
cent; brokerage, one-eighth of one per cent; landing, cartage, etc., one- 
fourth of one per cent. Let us take nine-tenths of one per cent as the 
basis for our calculations. In ascertaining the value of one Shanghai 
tael in terms of shillings and pence, the exchange dealers use what is 
called a “constant,” which when multiplied by the price of silver in 
London, gives the value of a Shanghai tael in terms of English money. 
The constant is derived in the following manner: If it costs nine-tenths 
of one per cent to ship one Shanghai tael to London, the cost of 
procuring and shipping roo Shanghai taels would be 100.90 Shanghai 
taels. We know that in weight 111.20 Shanghai taels equal 100 Can- 
ton taels. The weight of the Canton tael is 579.84 grains troy. Bar 
silver in London is quoted on the basis of 222/240 fineness; in Shang- 
hai on the basis of 2393/240 fineness. 

In working out a problem of this sort, resort is aincet always had 
to the “chain rule.” This process resolves itself into an arrangement 
of equations, the first of which states the problem. In the instance 
under discussion we want to know the figure which, when multiplied by 
the London price of silver, will give us the value of the Shanghai tael. 
The left side of the second equation must be in terms of the right side 
of the first equation: and so on until we have as the right side of the 
last equation an amount expressed in terms of the left side of the first 
equation. The product of the equations on the right side is then 
divided by the product of the equations on the left side, and the 
quotient is the desired result. 

Working out our problem by means of the “chain rule”? we have 
the following: 


? = 1 Shanghai tael 

100 Shanghai taels plus charges = 100.90 Shanghai taels 

111.20 Shanghai taels = 100 Canton taels weight 

1 Canton tael weight = 579.84 grains troy 

222 grains standard silver = 239% grains Chinese standard silver 
480 grains silver = London price for silver 


100.90 X 579.84 X 239.5 


= 1,192, - constant 
EID 4207 4g 22 ASO 


450 DOMESTIC AND FOREIGN EXCHANGE 


The above calculation gives us the constant that is used as the basis 
for computing the value of the Shanghai tael in terms of English 
money. With silver in London, say, at 49!4d. per ounce, the “parity 
of silver” would be 58.50d. or 4s. 1014d (49.5 X 1.182). This “parity 
of silver’ would be used by the Chinese bankers in figuring the rate 
to be charged for the Shanghai tael. The silver parity would, of course, 
fluctuate as the price of silver in London changed from day to day. 
The various factors affecting the rates of exchange, which we have 
already discussed, would raise or lower the actual market rate above 
or below this parity, depending upon the strength or weakness of the 
elements concerned. 

During the period since the war, with the London quotation of silver 
based on the New York quotation, the formula has been modified 
somewhat by bringing in the cross-rate between London and New 
York and also the charges from New York to Shanghai, approximating 
about two per cent. If the price of silver in New York is $1.01%4 per 
ounce, oo ounces are worth $101.50. Taking the cross-rate between 
New York and London at 4.761%, the formula then appears as follows: 
dee = one Shanghai tael 
111.20 Shanghai taels = roo Canton taels weight 
82.7815 Canton taels = 100 troy ounces 


100 troy ounces = $103.50 (New York silver price plus 2% charges) 
$4.76% gold = 240d. 


103.50 X 240 X I00 
TIT. ZOUK Os yOrS oh do 20S 

It will be noted that the New York parity is 1 7/8d. lower than the 
London parity obtained in our computation above, but the London 
computation included charges, interest, etc., from New York to Lon- 
don, which are heavier than those from New York to Shanghai. 

If one desires to use the above New York computation for the pur- 
pose of arriving at the parity of Shanghai taels in terms of American 
gold dollars (with the price of silver in New York at $1.014 per 
ounce), the following formula can be used: 


= 56.63d. or 4s. 8 5/8d. 


? gold dollars = 1 Shanghai tael 
1 Shanghai tael = 4s. 8 5/8d. or 56.63d. 
240 d. = $4.76% 

56.63 X 4.765 


= $1.1243 gold 
240 f 


Cites ————————————————  — 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 451 


Therefore with silver in New York at $1.0114 per ounce, the New 
York parity of the Shanghai tael would be $1.1243 gold. 

If one wishes to obtain the value of the Shanghai tael in terms of the 
American dollar, without using the London parity, it can be obtained 
by means of the following formula: 


? gold dollars 1 Shanghai tael 

111.20 Shanghai taels = 100 Canton taels weight 

82.7815 Canton taels = 100 ounces troy 

I ounce troy $1.031% (New York price of silver plus 2% charges) 


I 


100: X T6O 71045 
tenn ee oT 21243 201d 
TL 20 C02.700% 


These parities represent, as it were, the “par of exchange” for China 
in dealing with London and New York. There can be no real par 
of exchange between a gold standard and a silver standard country. 
For the purpose of buying and selling exchange on gold standard coun- 
tries, the value of the silver exchange in terms of gold has to be as- 
certained from day to day or from hour to hour, and used as a basis 
for exchange calculations. As the price of silver changes the “silver 
parity”’ necessarily changes. 


B. Gotp EXCHANGE STANDARD ! 


During the roth century, the developing needs of commerce and 
industry required a more stable form of currency than was possible 
under either the bimetallic standard or the silver standard, and as 
the years passed the more progressive nations of the world one by one 
adopted the gold standard. In brief, this action meant providing for 
the free and unlimited coinage of gold, making a gold coin of some 
kind the standard or unit of value, giving to gold coins full legal tender 
qualities, and authorizing the redemption of other forms of money 
either directly or indirectly in gold. Several of the Oriental countries, 
however, were so accustomed to the use of silver and were so entirely 
without any internal need for gold coins, that it was neither advisable 
nor possible for them to abandon silver so completely as did the more 
advanced nations. For these Oriental countries a sort of halfway 
house was devised, i. e., the “gold exchange standard,” and this 


1For a more detailed discussion of the gold exchange standard and its application to 
various countries, cf. Kemmerer, E. W., ‘‘Modern Currency Reforms,” Parts I, III, IV, 
V; Keynes, J. M., “Indian Currency and Finance”; Shirras, G. F., ‘“‘Indian Finance and 
Banking’’; Spalding, W. F., ‘‘ Eastern Exchange, Currency and Finance,” Chaps. 1-6, 11-12, 


19. 


452 DOMESTIC AND FOREIGN EXCHANGE 


standard is now in effect in India, the Philippine Islands, Siam, the 
Straits Settlements, and the Dutch East Indies. 

Briefly, the gold exchange standard provides a gold standard in a 
silver using country, without the necessity of gold coins being actually 
in circulation. The monetary unit of a nation possessing a gold ex- 
change standard is maintained at par by always being kept redeemable 
either in exchange on some gold standard country or in the more stable 
monetary unit of the latter. For instance, the silver rupee of India 
was until 1919 tied to the pound sterling of England through sales and 
purchases of exchange, but since that time it has been legally, though 
not in practice, tied to the gold sovereign. In the Philippines, the 
silver peso is tied to the American gold dollar by means of exchange 
transactions. Before the World War rupee exchange could be pur- 
chased in England and sterling exchange could be purchased in India 
at approximately fixed rates; Filipino pesos could be purchased in 
the United States and American dollars in the Philippine Islands 
at fixed rates. In this way in normal times the value of the monetary 
unit of the gold exchange standard country has been held closely to its 
legally fixed rate of convertibility. To assist in maintaining it at that 
point, reserve funds are kept both abroad and at home. As Keynes 
has well said, “The Gold Exchange Standard may be said to exist 
when gold does not circulate in a country to an appreciable extent, 
when the local currency is not necessarily redeemable in gold, but when 
the Government or Central Bank makes arrangements for the pro- 
vision of foreign'remittances in gold at a fixed maximum rate in terms 
of the local currency, the Reserve necessary to provide these remit- 
tances being kept to a considerable extent abroad.” 4 

To illustrate more clearly how the exchanges may be used in the 
stabilization of a nation’s monetary system, we may confine our dis- 
cussion to India, with but a slight reference to the system adopted by 
the Philippine Islands. Up to 1893, India, because of her adherence 
to the silver standard, experienced the same disastrous effects as has 
China. The value of her rupee, containing 165 grains of pure silver, 
fluctuated with the price of silver. From 1873 to 1893, as a conse- 
quence of the fall in the price of silver, the value of the bullion content 
of the rupee decreased 40 per cent. The average London rate on India 
in 1873 was 1s. 10 3/4d. per rupee. By 1893 it had fallen below 1s. 3d. 
From our discussion of the Chinese situation, it can be seen that such 

10p. cit., pp. 30-31 





EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 453 


a serious decline in the value of the rupee would work to the disadvan- 
tage of India in her foreign relations. She annually owed the British 
government large sums of money for interest, pensions, taxes, etc., 
and she owed foreigners for goods purchased, all of which she had to 
pay in terms of her depreciated currency. Her foreign trade suffered 
because of the uncertainties of rupee exchange. Speculation in ex- 
change was widespread. Finally in 1893, in an effort at relieving the 
situation somewhat, the Indian Mint was closed to the free coinage 
of silver, and the government agreed not to add new rupees to the 
country’s circulation. The fundamental idea underlying the reform 
was to create a shortage of rupees, and thus bring about an increase 
in their value. The government also announced that it would ex- 
change gold at the rate of 1s. 4d. per rupee, or 15 rupees to the pound 
sterling.! By this act, the value of the rupee was divorced from the 
value of its bullion content and connected semi-officially with the 
more stable pound sterling. In short, the rupee became a token coin, 
its face value or the value at which it was to be accepted in business 
being greater than the value of its silver content. It seemed at that 
time that there was no possibility of its metallic content ever being 
worth 1s. 4d. because the prospects were that silver would always re- 
main at a level lower than that of 1873. Silver would have to sell for 
43d. per ounce before the melting point of the rupee would be reached. 

As the years passed, the rupee in the exchanges rose slowly until it 
reached 1s. 4d., whereupon the government in September, 1899, took 
steps to maintain it at that level. The government legally established 
the relation between the rupee and gold by decreeing that the sovereign 
and half-sovereign were to be legal tender in India; rupees also were to 
be legal tender, but not convertible into gold, although convertible 
into exchange on London at the rate of 1s. 4d. per rupee. A Gold 
Standard Reserve was provided for, to be gradually accumulated 
from the profits of rupee coinage. With standard silver at 24d. per 
ounce, the silver in the rupee would cost the government only 9g.181d., 
and at 32d. per ounce it would cost but 12.241d. The difference be- 
tween the value of the silver used by the government in coining rupees 
and the legal value of the rupee (in other words, seigniorage) was to be 
deposited in the Gold Standard Reserve Fund. The average profit 
which the government received from the coinage of rupees during 


1Calculated on the basis of £1 sterling = $4.8665, this rate of conversion placed the 
value of the rupee at 34.44 cents. 


LA DOMESTIC AND FOREIGN EXCHANGE 


1910-12, amounted to about 42 per cent of the face value of the coins 
minted. Rupees were to be coined and paid out by the government 
only in return for gold, or in exchange for Council Bills, i. e., exchange 
on Indian Treasuries, sold in London by the Secretary of State for 
India. As the Gold Standard Reserve has grown, a portion of the 
fund has been invested in securities, the interest therefrom also being 
added to the Reserve. On March 31, 1914, the Reserve totaled ap- 
proximately £25,510,000 of which all but £4,000,000 was held in 
London at the Bank of England. Of the total, £17,165,000 was in 
the form of securities, £4,320,000 in gold, £4,000,000 in silver, and 
£25,000 in cash loaned out on call. In March, 1919, the Reserve had 
increased to about £36,000,000. The rupee noles issued by the goy- 
ernment are sustained by a Paper Currency Reserve. We shall not 
concern ourselves with the details of Indian paper money in this brief 
résumé of India’s monetary and exchange problems. Both of these 
Reserves are under the control of the Secretary of State for India, 
who has, since 1899 and until 1917, employed them most successfully 
(with few exceptions) for the purpose of maintaining the rupee at the 
designated par of 1s. 4d. The manner in which he has done this will 
be explained shortly. 

Even though India suffered until 1899 from the effects of a fluctu- 
ating silver standard she did not have to undergo the disadvantages 
arising from the complexities of a confused and diverse currency made 
up of every conceivable form of money, as is the case even today with 
China. India’s monetary system is fairly simple. The pice is a bronze 
coin and contains 75 grains troy. There is also a half-pice and a pie 
(one-third of a pice), both of which are bronze and of proportionate 
weight. A one anna piece of nickel (60 grains troy) is coined, as are 
also four and eight anna pieces of the same metal. A pice is the 
equivalent of 14 anna. The silver rupee contains 160 grains of fine 
silver or 180 grains of silver 11/12 fine. An eighth, quarter, and half 
rupee are also coined. Under the gold exchange standard as it existed 
down to 1919, the rupee was /egally the equivalent of 1s. 4d. (15 rupees 
=f£1). In 1919 the legal rate of conversion was changed to 2s (10 
rupees =£1). A gold mohur, of the same weight and fineness as the 
British pound sterling (123.27447 grains 11/12 fine), was issued in 1918 - 
at the legal value of one mohur equals 15 rupees, but by a later edict — 
of the government, this coin has been called in and demonetized to \ 
the newer ratio of ro rupees, established in 919. There is also a system \ 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 455 


of governmental notes, supported by the Paper Currency Reserve, 
which need not concern us in this brief discussion of the Indian ex- 
changes. 

To stabilize Indian currency and exchange at the designated rate 
of 1s. 4d. per rupee, resort was had to two devices. First, it was 
necessary to have a gold fund somewhere, not necessarily in India 
itself, as a reserve or security behind the silver rupee, which might 
be used in case of need. It was to provide such a fund that the Gold 
Standard Reserve was established for the silver rupee and the Paper 
Currency Reserve for the Indian paper money, both of which funds 
were deposited for the most part with the Bank of England. Second, 
it was also necessary to provide some means whereby the government 
could dominate the sale of exchange, both in London on India and in 
India on London. Inasmuch as practically all Indian transactions 
pass through or are controlled directly or indirectly by London, it was 
only necessary to control the rupee on or from that point, because 
the rupee rate in other countries would, through the workings of the 
cross-sterling rate in those centers, tend very closely to approximate 
the rupee rate as fixed in the London market. The Indian government 
therefore established the practice of selling exchange in London on 
India (“Council Bills,” payable by the Indian Treasuries at Calcutta, 
Madras, and Bombay) and in India (Calcutta) on London (“Re- 
verse Council Bills’’) at fixed rates and in amounts sufficiently large 
to control the market. Thus does the system adopted by India fully 
satisfy the requirements laid down by Keynes for a gold exchange 
standard. Gold coins do not circulate to any extent in India. The 
local currency of the country was originally not redeemable in gold, al- 
though it was convertible into sterling exchange at the designated 
rate. The law was later amended and the rupee is now legally redeem- 
able in gold, although in practice, owing to post-war conditions, con- 
vertibility is not maintained. The government provides for remit- 
tances, both in London on India and in India on London, at fixed 
maximum rates. Finally, the greater part of the reserve funds is kept 
abroad. 

By making the rupee always convertible into sterling exchange at a 
fixed rate, the value of the rupee both at home and abroad was stabi- 
lized as thoroughly as though India herself were on the gold standard. 
The rupee could not rise above or fall below the fixed rate of 1s. 4d. 
to a greater extent than the cost of shipping gold to or from India so 


456 DOMESTIC AND FOREIGN EXCHANGE 


long as the government was able to control the market by supplying 
all of the exchange demanded, either in London on India or in India 
on London. In both centers the government acted as a supplier but 
never as a buyer of exchange. There was never any need for it to be- 
come a buyer in either market because by supplying rupee exchange 
in London it could keep the rate in London on India from rising to 
too high a level (and conversely the rate in India on London from fall- 
ing to too low a level) and by supplying sterling exchange in India 
it could keep the rate in India on London from rising to too high a 
level (and conversely the rate in London on India from falling to too 
low a level). One of the reasons why in the case of India, this system 
has almost without exception worked satisfactorily, is that India 
is a country which, as Spalding says, “would have brought joy to the 
hearts of the old Mercantilists—her international credits nearly 
always ”’ exceeding her debits.!_ In normal years, her exports of com- 
modities are about 50 per cent greater than her imports.” India, 
therefore, normally expects to receive payments from abroad aggre- 
gating from £40,000,000 to £50,000,000 a year. Over against this, 
however, are the extremely heavy payments that India has to make 
in England, consisting of shipping and insurance charges, interest 
payments on national and private debts, remittances to families resid- 
ing in England, returns from Indian railways and other enterprises, 
pensions, allowances, etc. The Indian government always needs 
funds, actual money, in England. English banks, importers, and in- 
vestors, on the other hand, always need funds in India. In order to 
transfer funds from the Treasury of India to England so as to pay 
the “home” charges, i. e., the debts of the government of India to the 
English government and to English creditors, amounting normally 
to about £20,000,000, the Secretary of State for India sells rupee ex- 
change (“Council Bills””), which is to be paid in rupees from the funds 
of the Indian government on deposit with the Indian Treasuries at 
Calcutta, Madras, and Bombay. This exchange is redeemed or paid 
at the rate legally fixed by the Indian government. ‘The rate of 
redemption as noted above, was formerly 1s. 4d. per rupee, but at 
present it is supposed to be 2s. per rupee. In normal times, the Secre- 
tary of State sells exchange only on India. If exports fall off and an 


1 Spalding, “‘Eastern Exchange, Currency and Finance,’ 1920 ed., p. 23. 
2 Average excess of exports for ten pre-war years, 51%; average for five war years, 


52%. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 457 


adverse balance of trade develops, requiring India ! to make greater 
expenditures in England, with less chance of offsetting them by Eng- 
lish payments to parties in India or to the Indian government, it then 
becomes necessary for the Secretary of State for India to sell “Re- 
verse Council Bills,” i. e., exchange in India on London. These bills 
may be obtained by paying rupees to the exchange offices of the gov- 
ernment of India and receiving therefor exchange on London at the 
fixed sterling rate, i. e., formerly 1s. 4d. per rupee; at present 2s. per 
rupee. This proceeding, as the reader can appreciate, is merely the re- 
verse operation of that which occurs in the sale of Council Bills, and en- 
ables the government to transfer funds from London to India, whereas 
in the case of the issuance of Council Bills, the funds of the government 
of India are transferred to London. With Reverse Councils the gov- 
ernment receives rupees in India for sterling exchange on London; with 
Council Bills, it receives sterling in London for rupee exchange on India. 

A favorable balance of trade in the case of any country normally 
causes the value of its standard monetary unit to rise, because the 
surplus of drafts on other countries results in the weakening of the 
exchanges of those countries. An unfavorable balance creates a re- 
verse condition. 

Normally, the Secretary of State for India sells Council Bills on 
Bombay, Madras, or Calcutta, chiefly on the last center. When these 
drafts on India are presented to the government for payment, it pays 
out rupees. The rupees thus added to the supply already in circu- 
lation tend to keep the value of the rupee from rising. Selling Council 
Bills at the fixed rate, also prevents rupee exchange from rising above 
that figure and keeps rupee exchange in London at the designated 
level. On the other hand, if an unfavorable balance of trade arises, 
and India has to remit heavily to England, sterling exchange will 
normally rise as a consequence of the greater demand in India for 
sterling bills on London. The Indian government, however, stands 
ready to sell to Indian remitters all of the sterling exchange that they 
need and at the fixed price. It accepts rupees in payment therefor. 
The sale of these Reverse Councils therefore withdraws rupees from 
circulation and tends to raise the value of the rupee or to prevent it 
from falling. Because of the customary favorable balance of trade, 
the Secretary of State for India has seldom had to resort to the sale 
of Reverse Councils. 


1 Including payments by individuals, firms, and the government of India. 


458 DOMESTIC AND FOREIGN EXCHANGE 


Selling exchange at a fixed rate makes it unnecessary for bankers 
and others in either country to pay more than that rate. The reserve 
funds may be called upon whenever necessary to enable the Secretary 
of State for India to support the rupee rate against an adverse con- 
dition of affairs, as was done in 1907-08 and also at times during and 
after the World War. 

The Indian government, therefore, is the real source of the supply 
of exchange both in India on London and in London on India. It does 
not deal with the general public, however, but only with banks, bankers 
and exchange dealers. It is not compelled by law to sell Councils or 
Reverse Councils to supply the needs of trade. Its sales for govern- 
mental purposes, however, normally take care of the requirements 
of Indian foreign trade. 

The plan followed by the Secretary of State for India in the sale of 
Councils or Reverse Councils may be summed up as follows: “Every 
Wednesday a notice is exhibited at the Bank of England, on the au- 
thority of the Secretary of State for India, inviting tenders, to be 
submitted on the following Wednesday, for India Council bills of ex- 
change and telegraphic transfers drawn on the Government treasuries - 
at Bombay, Calculta and Madras. The notice states a limit which 
the aggregate amounts will not exceed, and tenders for either form 
of remittance must be for so many lacs of rupees—a lac being equal to 
100,000 rupees.! Each applicant specifies the center at which he wishes 
the remittances to be payable. There is no obligation on the part 
of the Secretary of State to allot the whole amount mentioned in the 
notice, and, as a general rule, applications at rates lower than Is. 
3 29/32d. per rupee for the bills and 1s. 3 15/16d. for the telegraphic 
transfers are not accepted. The price charged for the latter form of 
remittance is ordinarily higher by 1/32d. per rupee than that charged 
for bills,” 2 because approximately fourteen days’ time is saved by 
means of such transfers. If the Bank rate in India is 9 per cent or 
above, telegraphic transfers are sold at 1/16d. higher than Council 
Bills. The allotment of the week’s offering is made to the highest 
bidders. If the amount demanded by the purchasers exceeds the 
amount which the Secretary of State for India has offered for sale, 
the allotment is made on a pro rata basis. The Secretary also sells 
what are called “Intermediate Councils” or “Specials.” These are 


100 lacs = 1 crore. 
2 Spalding, ‘‘Eastern Exchange, Currency and Finance,” p. 33. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 459 


bills or telegraphic transfers that are sold by the Secretary on days 
other than Wednesday, the rate never being less than 1/32d. above the 
price at which the Wednesday offerings have been sold. During the 
World War a new type of transaction, called a “Deferred Council” 
was introduced. The mails between London and India were so un- 
certain that the Secretary offered telegraphic transfers for sale that 
were deliverable and payable in India sixteen days after their purchase 
in London. 

Although a gold exchange standard country does not enjoy the 
free and unlimited coinage of gold and is not ordinarily compelled 
to pay out gold in the redemption of its circulation, nevertheless its 
exchange does fluctuate around a par of exchange. Its exchange rates, 
therefore, are controlled, as is true also of a gold standard country, 
by the gold or specie points. Until the phenomenal rise in the price 
of silver broke down the gold exchange standard of India, her par 
of exchange was 1 rupee = 1s. 4d. To ship gold from London to India 
costs normally about 1/8d. per rupee. Under normal conditions the 
rate for Council Bills (sight drafts on India) therefore could rise no 
higher than 1s. 4 1/8d.; in fact, the Secretary of State for India for 
many years had maintained an offer of an unlimited supply of Council 
Bills at that rate, with telegraphic transfers at 1s. 4 5/32d.! If the rate 
on India should rise above the legally fixed par of exchange plus ship- 
ping costs, gold in normal times will leave England for India or the 
British bankers will procure gold from other sources (possibly gold in 
transit from Australia to London, or ready for shipment in Egypt) 
and send it to India where it will be presented to the Indian Treasuries 
and redeemed in rupees at the legally fixed rate. The possibility of 
diverting to India gold that is in transit from Australia to England 
involves an interesting transaction. If a banker is bringing gold to 
London from Australia and if the rupee rate in London rises so high 
astomakeit worth his while to divert the gold to India, he will do so. 
Or he may sell the gold to another banker in London with the under- 
standing that the gold is to be deposited in India. By this means gold 
is delivered in India at least fourteen days earlier than an English 
banker could forward it to India from London, and the importing 
London gold merchant gets his money in England fourteen days 


1In January, 1900, however, the telegraphic transfer rate rose to 1s. 4 3/8d. and from 
December, 1906, to March, 1907, stood at 1s. 4 3/16d. because of the high bank discount 
rates prevailing in India. 


460 DOMESTIC AND FOREIGN EXCHANGE 


earlier because he receives payment from the English purchaser as 
soon as the gold arrives in India. Before the World War, the importing 
merchant would probably accept rs. 3 31/32d. in London for the gold 
diverted to India in this manner, which gold was formerly worth ts. 4d. 
per rupee on its arrival in India. Telegraphic transfers on India, as we 
have seen, are usually 1/32d. higher than Council Bills. Thus before 
the system was changed, if the rate for Council Bills in London rose 
to a higher level than ts. 3 15/16d., gold in transit from Australia 
could and did compete with Council Bills as a form of remittance to 
India. In the case of Egyptian gold ready for shipment to London, if 
Council Bills sold for more than 1s. 4d., there was a possibility that 
the gold might be more profitably forwarded to India from Egypt 
rather than to London. The gold exchange standard of India broke 
down so badly after 1917, and the control of the British government 
over gold shipments is still so complete, that it is impossible to state 
just what the gold points of the rupee are at the present time (April, 
1922). 

The reverse movement of gold, that is, from India to London, is 
not normally a possibility. India is our great “gold and silver sink.” 
It is the greatest absorber of the precious metals that the world has 
ever had. Banking in India is backward and inadequate; money does 
not circulate rapidly; checks are almost unknown; the average family 
holds its own funds and acts as its own banker; social customs require 
much gold and silver. These matters explain India’s ability to absorb 
gold and silver in untold amounts. Although Council Bills have been 
known to fall below the former gold import point of 1s. 3 29/32d. (as 
in 1895 when the rate of 1s. 1d. was reached), nevertheless, the Secre- 
tary of State has the means at hand for strengthening the rate if he so 
desires. If the rate weakens considerably, he may announce a smaller 
weekly offering of Council Bills. If that is not sufficient to strengthen 
the rate, he may withdraw entirely from the market. If neither action 
brings the expected result, he may, as a last resort, begin selling Re- 
verse Councils in India on London. The government under the old 
scheme of things was pledged to keep the rupee at not less than ts. 
3 29/32d. and until the gold exchange standard broke down it did 
not hesitate to do everything within its power to keep the rate from 
falling below that point. 

When gold is exported to India and exchanged at the Treasuries 
for rupees the Secretary of State’s gold holdings increase in India. If 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 461 


the demand for rupees becomes too great and more rupees have to be 
minted, the gold on deposit in India may have to be shipped to London 
and used to purchase silver with which to coin more rupees. This prac- 
tice, however, involves a double loss: first, the cost of shipping gold 
from India to London, say 3/32d. per rupee; second, the loss incurred 
by the Secretary of State in letting gold go to India because of the 
higher rate, rather than to sell his bills for 1s. 4 1/8d. or 1/8d. more 
than par. It is not unusual, however, for the Secretary of State to 
allow gold to be sent to India so as to build up a larger gold reserve 
in that country to be used if necessary in time of need. 

There were several instances before the World War when India was 
forced to protect the rupee rate from falling below 1s. 3 29/32d. Dur- 
ing the panic of 1907-08, because of the lack of demand for Indian 
exchange, the rate showed signs of excessive weakening, falling to 
1s. 3 11/16d. on November 25, 1907. The government thereupon 
stopped the sale of Council Bills and during the latter part of Decem- 
ber began to sell Reserve Councils.1_ In August and September, 1909, 
Indian exchange again weakened and necessitated the sale of Reverse 
Councils. Upon the outbreak of the World War, the Indian govern- 
ment was again faced with the problem of maintaining its exchange 
rate. On August 3, 1914, it announced that it would sell Reverse 
Councils and telegraphic transfers on London to the extent of £1,000,- 
ooo a week. From that date until the following January, £6,807,000 
were disposed of at the rate of 1s. 3 29/32d. per rupee and were very 
effective in steadying India’s exchange.” Steps were also taken to 
prevent the depletion of the Indian government’s gold holdings. 
Reverse Councils were again sold in 1915, 1916, 1918, 1919, and 1920, 
until finally on September 28, 1920, the status of the exchanges com- 
pelled the Indian government to cease all attempts to support the 
rate.” 

The story of the gold exchange standard of India during and after 
the World War is a story of the close connection between the astound- 
ing rise and fall in the price of silver and the complete breakdown of 
the exchanges of a country whose standard of value for internal pur- 
poses is a silver coin. During the uncertain days of the fall of 1914, 


1 Approximately £8,058,000 of Reverse Councils were sold at that time at the rate of 


Is. 3 29/32d. 

2 Telegraphic transfers were sold at first at 1s. 3 13/16d. but the rate was later raised to 
1s. 3 27/32d. when the Bank of England reduced its discount rate to 5 per cent. 

8 During that period the rate had fallen from 2s. 4d. to about 1s. 4d. 


462 DOMESTIC AND FOREIGN EXCHANGE 


the gold exchange standard of India surprised even its most ardent 
supporters by the manner in which it withstood the stress and strain 
of that period. Nothing further occurred until in the latter part of 
1916, when the effects of an increased trade balance and the rise in 
the price of silver began to be felt through an increased demand for 
Council Bills. The prohibition of the export of gold by England re- 
moved one means of settling the Indian balances and intensified the 
seriousness of the situation. Toward the close of December, 1916, 
it became evident that conditions would force the rate for Council 
Bills to higher levels. To meet the situation, the Secretary of State 
raised the rate in January to 1s. 4 5/32d. for Council Bills, and to ts. 
4 1/4d. for telegraphic transfers. These rates were more or less satis- 
factorily maintained until August 27, 1917, when they were increased 
to 1s. 4 29/32d. for Council Bills and 1s. 5d. for telegraphic transfers. 
The continued rise in the price of silver, linked with the great balance 
of trade, again compelled the Indian government to revise its official 
rates, and on April 20, 1918, the price of Council Bills was fixed at 
Is. 5 29/32d., with telegraphic transfers at 1s. 6d. At those levels the 
silver rupee in India was temporarily removed from the danger of the 
melting pot. When in May, 1o19, the United States abandoned its 
control over the silver market, the Secretary of State for India raised 
the rate for Council Bills to 1s. 7 15/16d. and for telegraphic transfers 
to 1s. 8d. On August 12, the rates were again increased to ts. 9 15/16d. 
and ts. rod. respectively; on September 15, to 1s. 11 15/16d. and 2s. re- 
spectively; on November 22, to 2s. 1 15/16d. and 2s. 2d. respectively; 
and on December 16, to 2s. 3 15/16d. and 2s. 4d. respectively. The 
necessity for so frequently modifying the official rates led the Secretary 
of State for India to appoint a commission to study the exchange and 
currency situation.! The report of the Commission rendered on 
February 2, 1920, made a number of recommendations, only a few of 
which are of interest to us in connection with the present discussion.? 
It was urged that the legal conversion rate of the rupee be changed 
from ts. 4d. to 2s. and that instead of its being linked with the pound 
sterling (i. e., a bill of exchange) it be linked with the gold sover- 
eign and be accepted as the equivalent of 11.3 grains of pure gold. 
It was felt that, inasmuch as the pound sterling was at that time 


1 Appointed May 30) 1910. 
2The report of the Commission is excellently summarized in the Federal Reserve Bul- 
letin of March, 1920, pp. 253-258. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 463 


depreciated in the world’s exchanges, and would for some time remain 
a fluctuating quantity, it was better to link the rupee directly to a fixed 
weight of gold than to a variable amount of foreign exchange. It was 
also urged that India remove all restrictions on gold and silver ship- 
ments. The Indian government adopted practically all the recom- 
mendations of the Commission in the expectation that its difficulties 
would thus be satisfactorily solved. The results obtained to date 
have been far from encouraging. Almost immediately after the Com- 
mission had made its report, the price of silver began to decline in a 
most spectacular manner. The Commission had thought that silver 
would unquestionably remain at a fairly high level because of the 
Chinese demand and because of the withdrawal of the United States 
government from the international silver market.! As silver declined, 
the market rate for rupees eased off rapidly. The Indian government, 
however, continued to sell exchange on London at the rate of one 
rupee per 11.3 grains of pure gold or ten rupees per sovereign. On 
July 9, 1921, the pound sterling was worth 20 rupees in the market, 
a premium of roo per cent. England was not a free gold market. 
A premium was being paid for gold, both in England and in India. 
The difference between the Indian rate of the government and the 
market rate finally became “so pronounced that the Government was 
obliged to change the rate from to rupees to a sovereign to Io rupees 
to a pound sterling.” Instead of the problem being how to keep down 
the price of the rupee, it now became one of how to keep it up.” The 
extensive sale of Reverse Councils had no effect. Importers who had 
bargained for goods on the basis of 10 rupees to the sovereign were 
faced with the necessity of giving 15 or 20 rupees instead.* A further 
complication arose from the fact that India’s trade balance was 
strongly against her for some months. From February to September, 
1920, the Indian government sold over £50,000,000 of Reverse Councils 


1As a result of its purchasing only domestic silver under the terms of the Pittman Act. 

2 Federal Reserve Bulletin, January, 1921, p. 31. 

8 A report by the Senior Trade Commissioner in India during the latter part of 1921 con- 
tained the following significant statement: 

“Enormous quantities of high-priced goods began to arrive at Indian ports and this flood 
of imports, coinciding with a slump in the export trade, led to a heavy adverse trade bal- 
ance against India of 49 crores. Silver in London fell from 72d. to 30d. per ounce during 
the year and the exchange value of the rupee from 2s. 4d. on April rst, 1920, to 1s. 2 7/8d. 
on March 7, 1921. Importers were faced with heavy losses on goods purchased at high 
prices, the shipments arriving when the markets were stagnant. In the meantime the 
exchange value of the rupee had fallen to a low mark. An additiotlal menace was the lower 
prices ruling in the producing centres, importers having to consider the probability of being 
undersold by more recent purchases.” 


464 DOMESTIC AND FOREIGN EXCHANGE 


with no appreciable affect upon the exchange market. During that 
period the rupee rate fell from 2s. 4d. to 1s. 4d. All efforts of the 
government to maintain the rupee at its legal ratio of 2s. have failed 
thus far and it now seems as though matters were to be allowed to 
take their natural course, unhindered by governmental intervention. 

“The rupee cannot, however, be expected to rise to and remain at 
its par value in exchange transactions until it becomes freely con- 
vertible into gold in India, and in turn convertibility can hardly be 
expected so long as gold commands a substantial premium in the 
market. It appears, therefore, that the new ratio of ro rupees to I 
sovereign will remain purely theoretical so long as the market price of 
gold will exceed by a considerable margin the statutory ratio of 1 
rupee for 11.3 grains of gold, or ro rupees per sovereign, while the 
minimum below which the price of the rupee cannot fall is the value 
of its silver content. So that, in effect, the value of the rupee at the 
present time is more closely connected with the price of silver than 
with the rupee’s statutory gold value.” 4 

If, with the return of normal trade conditions, the rupee does not 
rise to its statutory rate, the Indian government will undoubtedly 
appoint another commission to investigate and recommend changes 
in the gold exchange standard and in the monetary system of the 
country. 

The gold exchange standard also legally exists in the Straits Settle- 
ments, the Dutch East Indies, Siam, and the Philippine Islands. It 
is not necessary for us to present the details of each of the systems as 
applied in these countries; suffice it to say that the fundamental 
principles are the same as those that characterize the gold exchange 
standard of India. A few words about the scheme as applied to the 
Philippine Islands might not be amiss because of our relations with 
that dependency. 

The reserve fund of the Philippine Islands is kept in New York and 
Manila. Drafts and telegraphic transfers are sold in Manila on New 
York and in New York on the Philippines, in sums of not less than 
10,000 pesos or $5,000 (U. S. money). A premium of 3/4 of 1 per cent 
is normally charged for sight drafts and 1 1/8 per cent for telegraphic 
transfers. The peso is thus tied to the American dollar and its stability 
at the statutory level is maintained in the same general manner as has 
normally been trué for the rupee. During and after the War, trade 


1 Federal Reserve Bulletin, January, 1921, p. 32. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 465 


conditions and the rise in the price of silver greatly upset the estab- 
lished order. The silver content of the peso rose in value to such an 
extent that pesos were being melted or exported from the country. 
The government vigorously enforced a law against exportation. In 
1919 the premium on telegraphic transfers was raised to 3 per cent. 
Finally in March, 1921, the sale of exchange was temporarily aban- 
doned because the reserve fund had fallen to such a low amount with 
no possibility of its being replenished.! For some time prior to that 
date, the government had been selling certificates of indebtedness 
to keep the fund intact, but, realizing that it could not carry the 
burden indefinitely, it temporarily abandoned the sale of exchange. 
On April 20, 1921, sales of dollar exchange were again resumed. Dur- 
ing the first few days a premium of ro per cent was charged, but as 
time passed it has been gradually reduced. 

Other gold exchange standard countries suffered in the same manner 
and from the same causes as India and the Philippine Islands. The 
last eight years (1914-1922) have been a most trying period for all 
exchanges and exchange systems. 


C. PAPER STANDARD 


The exchanges of gold standard, silver standard, and gold exchange 
standard countries are tied to some coin or fixed weight of precious 
metal, either gold or silver, in terms of which they are readily con- 
vertible. But an entirely different situation is presented in the case 
of those countries that are on an inconvertible ? paper money basis. 
Their standard monetary unit is not linked to a gold or silver coin or 
to a weight of precious metal. Their inconvertible paper money is 
money solely because the people are willing to accept it as such either 
at par or at a variable discount, usually the latter. It is secured only 
by the good will of the government and occasionally by the govern- 
ment’s promise to redeem it in specie at some indefinite future date. 
Its fluctuations have no fixed limits and know no specie points, nor do 
they follow the general rules that have been discussed in connection 
with the other exchanges. The causes of the variations in the value 
of irredeemable paper money or in the rates of exchange on a country 
having such a monetary standard are at times difficult to discover; in 


10On March 12, 1921, only $1,500,000 in gold remained in the New York Reserve Fund. 
2 Paper money not redeemable in specie on demand. 


466 DOMESTIC AND FOREIGN EXCHANGE 


fact, they present the most perplexing and confusing problem in the 
realm of exchanges. | 

The story of France and her assignats and mandats, and of our own 
bitter experience with inconvertible paper money during the Colonial 
and Revolutionary days and also during the Civil War period, is too 
well known to merit rehearsal here.1 The events of the past, however, 
have amply demonstrated that a small amount of inconvertible paper 
money may be issued and continue to circulate at par, but that as 
soon as an over-issue takes place, and the people lose faith in the ability 
of their government to maintain the parity of such money, it falls toa 
discount, the extent of its depreciation being gauged by the premium 
demanded for gold. [If it falls to a 25 per cent discount, gold com- 
mands a 25 per cent premium. For example, at one time during our 
Civil War, the inconvertible greenback currency dropped to a to per 
cent discount. To obtain $100 in gold, therefore, one had to pay 
$110 in greenbacks. 

The experience of every country on a depreciated paper money 
basis has demonstrated the truth of Gresham’s law which holds that 
“cheap or overvalued money tends to drive out dear or undervalued 
money in case of an over-issue (redundancy) of the former.” A depre- 
ciated paper money drives the more valuable gold and silver coins 
into hiding or out of the country. But if paper money becomes too 
greatly depreciated, the public may refuse to accept it and may de- 
mand gold or silver, or they may have recourse to the more stable and 
valuable money of another country. “There is an axiom among 
economists which has never been definitely explained, that once gold 
is free and allowed to seek its best market, the result will be that paper 
currency will gradually go into hiding.” * In England, for example, 
in 1813, about 500 banks were given note issuing power and a flood 
of paper money resulted. When specie payments were again resumed, 
gold went to a premium (110s.) and gradually drove paper out of cit- 
culation. The premium on gold disappeared and monetary con- 
ditions returned to normal. Instances of the use of the money of an- 
other country in place of depreciated paper currency are numerous. 


1Cf. White, A. D., “Fiat Money Inflation in France,’”’ New York, 1896; White, H., 
“Money and Banking,’’ Part II, Book I, Chapters 1-6, New York, 1914; Mitchell, W. C., 
“A History of the Greenbacks,”’ Chicago, 1903. 

2 The lowest level reached by greenbacks was on July 11, 1864, when they were worth 
$0.3509 on the dollar. Gold on that day commanded a premium of 285. 

3 Commercial and Finacial Chronicle, December 13, 1919, pp. 2216-17. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 467 


Since the Armistice, many travelers and writers have called attention 
to the fact that the American dollar is in great demand as money in 
certain of the European countries which are at present suffering from 
a depreciated and worthless paper money. Typical of the statements 
found especially in the foreign press is the following notice appearing 
in the “Weekly Review of Foreign Exchanges” of January 5, 1922, 
issued by Samuel Montagu and Company of London: “The ‘Isvestia’ 
(Russia) announces that henceforth foreign advertisers must pay one 
dollar a line in American currency. This is not the first time that 
Bolshevik financiers have tried to introduce the dollar as the basis of 
foreign transactions. But they even go farther. The People’s Com- 
missars have had now for some time before them a scheme for per- 
mitting business deals inside Russia to be transacted in dollars. The 
argument in favor of this plan is that the paper rouble is hopelessly 
depreciated, and that one cannot foresee when the price relative to 
foreign valuations will become stabilized.” 

In a country suffering from a depreciated paper currency, prices 
follow in a general way the rise or fall in the discount on such currency. 
As the discount rises, i. e., as the degree of depreciation becomes 
greater, prices in terms of the depreciated paper money rise because 
the paper money has cheapened, but the increase in the price level is 
not in exact proportion to the extent of the discount on the paper 
money. On the other hand, if prices are measured in terms of gold 
instead of in terms of depreciated paper money, no increase or 
possibly only a slight increase in the price level may be noted. 

Not only do domestic business and commerce suffer from the un- 
certainties of the situation, but foreign trade is also affected. Im- 
porters never know to what extent their home currency will have 
depreciated by the time they must pay for goods that have been pur- 
chased abroad. Every decrease in the value of the paper money is 
reflected in the exchanges, and calls for the expenditure of more home 
money in buying the needed exchange for remittance to the foreign 
exporter. Suppose that an Argentine importer has ordered some shoes 
from an exporting firm in the United States when the Argentine peso 
is at par, i. e., 100 per cent of its legally fixed value. The American 
firm draws a draft in dollars payable in Argentine pesos at the bank’s 
selling rate on New York. When the draft falls due and has to be 
paid, say that the peso has depreciated 5 per cent. If the price for’ 
drafts on New York has at the same time increased 5 per cent,—which 


468 DOMESTIC AND FOREIGN EXCHANGE 


in all probability would be the case,—the importer will have to give 
his banker 5 per cent more pesos than par to pay the draft. The im- 
porter, if possible, will pass the added cost on to the public in the form 
of higher prices for his goods. Argentine exporters will be similarly 
handicapped in their trading because they will be unable to calculate 
with any degree of certainty the amount that they will receive for 
their goods. If, for example, the peso falls in value, the exporter will 
receive more pesos for his draft drawn in foreign currency than if the 
peso rises. If the peso rises in value, it will be worth more in terms of 
the foreign money, and the exporter will get fewer pesos for his foreign 
draft. The greater the extent of the depreciation of the peso, the 
greater will be the peso returns of the exporter, and vice versa. 

It has long been urged that over a short period of time the ex- 
porters of a paper standard country are benefited by a depreciated 
currency and the resulting high exchange rates, i. e., the rates at which 
they can sell their bills of exchange, while the importers are injured by 
such depreciation. If the exporter feels that the exchanges are likely 
to remain depreciated for some time, he may even reduce his prices to 
foreign customers for the purpose of meeting competition. He may 
calculate that he is able to do this because depreciated exchanges re- 
sult in his getting more pesos for his goods than when the peso is at 
par. But his ability to compete in the market through the lowered 
prices made possible by the depreciated exchanges may be but tem- 
porary, because prices at home will rise soon after the paper money 
goes to a discount. Wages and other costs of production likewise in- 
crease, but not so rapidly as the paper money depreciates in value. 

Within a short time, therefore, the exporter may find himself in ap- 
proximately the same position as before the change occurred in the value 
of the currency and the exchanges. If perchance he is manufacturing 
his product out of materials imported from abroad, he will have to meet 
the increased costs of his materials brought about by his having to pay 
more for them owing to the depreciated exchange of his own country. 

Under a régime of depreciated paper money, practically every inter- 
national transaction becomes a matter of pure speculation. Daily 
fluctuations in the exchanges wipe out normal profits or compel the 
seller for safety’s sake to charge such high prices for ‘his goods as to 
handicap him greatly in building up his foreign trade. 

Several of the South American countries have fully appreciated the 
defects of an inconvertible paper money standard, both in domestic 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 469 


and foreign transactions, and have devised a method of stabilization 
that is unique in many respects. It embodies what might be called a 
double monetary standard. The basis of this peculiar monetary 
system is a gold coin, although gold coins are not in general circulation 
in those countries. The everyday medium of exchange is inconvertible 
paper currency, held more or less stable by being redeemable in gold 
through the instrumentality of a “Conversion Fund.” Argentina has 
been most successful in putting this plan into effect, Brazil less so, 
and Chile least of all. 

Argentina. Argentina! is legally on a gold basis, her monetary 
unit being the gold peso of 1.6129 grams of gold 9/10 fine. The gold 
peso is not in circulation. Her circulating medium is the paper peso 
which is of unlimited legal tender and which has a fixed ratio of 44 
per cent to the gold peso, i. e., 2.27 paper pesos are the legal equivalent 
of 1 gold peso. 7 To maintain the convertibility of the paper peso, the 
government in 1899 established a Conversion Fund from certain 
sources and deposited it with the Banco de la Nacion, which acts as 
the conversion agency. The story of Argentina’s experience with an 
inconvertible paper currency is interesting as indicative of how a 
country suffers through a fluctuating standard of value. In 1826 “a 
gold peso was worth 1.88 in paper; the next year the ratio was 3.53, 
and continued to increase uninterruptedly until 1840 when it was 
23.33; a Slight decline in the ratio was followed by a renewed rise and 
in 1864 the ratio was 28.84. For the period from 1868 to 1875 a fixed 
rate of 25 was maintained, but even at this high rate conversion could 
not be maintained and was suspended, with the result that the ratio 
still rose higher, reaching 32.2 in 1879. In 1881 a new monetary law 
was promulgated, establishing as a basis a peso containing 24.9 grains 
of gold or 383.8 grains of silver, both metals being 0.9 fine. Paper 
money was to be redeemed at par. The Government, however, was 
not able to maintain conversion and in 1885 paper money began to 
depreciate again, the ratio increasing to 3.87 by 1891. The year 1890 
was one of economic disaster in Argentina, with an acute financial 
crisis and many failures.” * 

Argentina, however, presented a case different in many points from 

1Cf. Williams, John H., ‘‘Argentine International Trade under Inconvertible Paper 
Money,” 1880-1900, Cambridge, Mass., 1920; Federal Reserve Bulletin, June, 1920, pp. 
592-7, March, 1922, pp. 314-316. 


2 A gold peso is divided into 100 centavos. 
3 Federal Reserve Bulletin, June, 1920, p. 593. 


470 DOMESTIC AND FOREIGN EXCHANGE 


that of a country operating on a real paper basis. To the date of the 
establishment of her Conversion Fund in 1899, her exchanges were 
carried on upon a gold basis. There was no “paper exchange”’ as such. 
Paper money was paid for gold, and gold in turn for exchange on for- 
eign centers. Gold moved freely into and out of the country as ex- 
change rates fluctuated above or below the so-called “specie points.” 
If exchange was too high, gold was exported; if too low, it was imported. 
Foreign business was conducted on a gold basis; domestic business on 
an inconvertible paper money basis. Gold was constantly at a pre- 
mium in terms of paper money. 

In 1899 the present system was introduced. It functioned most 
successfully until 1914, when the government suspended gold pay- 
ments at the conversion office. This decree is still in effect, although 
there has been an insistent demand that they be resumed. The gov- 
ernment maintains, however, that, inasmuch as practically all the 
European countries with which Argentina trades are on a depreciated 
paper basis, if she should begin paying out gold it would go to the 
United States to settle her unfavorable balance of trade, so that there 
would be no possibility of Argentina procuring gold in Europe to 
replenish her funds. This depletion of her supply might tend further 
to depress the exchange rate and seriously interfere with the stabili- 
zation of her currency. In December, 1921, Argentina held over 
480,600,000 pesos of gold in her Conversion Fund, against which 
1,362,564,000 paper pesos had been issued.! 

From 1914 to December, 1917, dollar exchange in Buenos Aires 
was maintained practically at par only by reason of our heavy ship- 
ments of gold.?, We were buying large quantities of goods from Argen- 
tina and not selling sufficient to offset her claims against us. When 
in the fall of 1917 we declared an embargo on gold shipments, the 
dollar went below par and remained at a discount of about 5 per cent 
until 1919 when we resumed gold exports. In 1920 the peso rate in 
New York declined and by December of that year it had fallen to about 
a 20 per cent discount. During 1921 it sank even lower, and closed at 

1In December, 1914, Argentina had 224,000,000 pesos in gold in the Conversion Fund, 
supporting 823,000,000 paper pesos. 

2In United States, exchange on Argentina is quoted in several ways, viz.: on the basis 
of the value of 100 pesos, or 1 gold peso, or 100 paper pesos, or 1 paper peso. The first 
and the last methods are more frequently followed. Thus, par is $96.48 per roo gold pesos, 
or $0.4245 per paper peso. Dollar exchange in Argentina is quoted at how many gold 


pesos is one dollar or $100 worth. Thus par is $1.00 = 1.0365 gold pesos, or $100 = 103.65 
gold pesos. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 471 


$74.8042 per 100 gold pesos (about $0.33 per paper peso). The reasons 
for this depreciation were her unfavorable balance of trade with us, 
her prohibition of gold exports, and her necessity of remitting large 
sums abroad for payment of interest on public debt and on private 
investments. 


1919, » 192 
FMAMJJASOND JFMAMJJASOND YF MAMJJ 
ae 


TON 
ae 
mek 


ae 
RERGGRRReERE Pee at TA 
Het H | eReveae 











Cuart IX 


High monthly rate for sight drafts on Argentina, Brazil and Chile in 
New York, 1914-1921 


Brazil. Brazil has also adopted the same plan for stabilizing her 
paper currency and her exchanges, but not quite so successfully as 
has Argentina.’ Brazil’s standard monetary unit is the gold milreis 
of 0.82207 grams of fine gold.” Gold coins of 5, 10, and 20 milreis 
are in circulation, but the gold milreis is not. The principal medium 
of exchange is the irredeemable paper milreis issued by the govern- 
ment.*? In 1906 Brazil obtained a loan from the British government 
and established a Conversion Office, the plan being to use the funds 
of this office in gradually retiring the inconvertible notes and issuing 
convertible paper in their stead. The government also has a guar- 


1Cf. Federal Reserve Bulletin, August, 1920, pp. 813-24. 

2In the money of the United States its par value is $0.5462. 

3A milreis is the equivalent of 1,000 reis. A thousand milreis is called a ‘‘conto.” 
Brazil has a unique method of separating the reis from the milreis by what is called a “‘ ci- 
fras,” or, “‘$” ; while thousands of milreis are separated from the hundreds by a colon (:). 
Thus, six thousand five hundred milreis and 450 reis would be written as: Rs. 6:500 $450. 


472 DOMESTIC AND FOREIGN EXCHANGE 


anty fund of gold used solely as security behind the outstanding con- 
vertible and inconvertible paper money.! The rate of conversion was 
first placed at 1 milreis to 15 pence in gold,” but in 1920 it was changed 
to 1 milreis to 16 pence in gold. Before the World War, whenever the 
exchange value of the paper milreis fell below 16 pence, “the holders 
of convertible notes would find it profitable to exchange them at the 
conversion office for the guaranteed amount of gold. The gold thus 
removed from the conversion office would be used for international 
payments, and this would tend to raise the exchange rate. On the 
other hand, when the value of the paper milreis rose above 16 pence, 
it would become more valuable than gold, and the public would take 
gold to the conversion office to exchange it for notes. This withdrawal 
of gold from circulation would in turn have a tendency to lower ex- 
change rates. In this manner the conversion office exercised a steady- 
ing influence on the exchange value of Brazilian currency.” * When 
the World War was declared, exchange fell steadily, and the run on 
the Conversion Fund became so serious that the government closed 
the office and suspended its operations. The office has remained 
closed to date (April, 1922). From 1914 to 1918 the Treasury paid 
out inconvertible notes for convertible paper and released a portion 
of the gold held in the Conversion Fund. This gold was used for ex- 
port purposes and for stabilizing the exchanges; a portion being also 
transferred to the guaranty fund as security for the inconvertible 
notes. The failure of the government to replace its inconvertible 
paper money with convertible notes is clearly shown by the table * 
on page 473. In 1918 and ro1g there was only 1,600,000 milreis 
in gold behind 21,000,000 milreis of outstanding convertible paper 
money. 

Exchange between New York and Brazil is quoted on the basis of 
the value of the paper milreis in terms of the American dollar. Par 
is $0.5462 per gold milreis, but there is no par for the paper milreis, al- 
though it is customarily placed at about $0.3244. Brazil quotes mil- 
reis to the dollar. In the exchanges the paper milreis varies con- 
siderably. In 1918 its value was estimated by the Director of the 


1In 1o19 the gold holdings of the government in the guaranty fund amounted to about 
48,000,000 milreis, or approximately 3 per cent of the paper money in circulation. 

2 Before the World War Brazil depended to a large degree upon English currency as a 
standard of exchange. 

3 Federal Reserve Bulletin, August, 1920, p. 814. 

4 Jbid. p. 815. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 473 


TABLE XX 


Note CIRCULATION OF BRAZIL 
(In 1,000 paper milreis) 


December 31— Convertible  Inconvertible Total 

COLI ae. tes 378,843 612,519 QQI,002 
RO LMe eee fess 406,036 607,025 1,013,061 
LOLAT INE Pe ot ass 205,347 601,488 896,835 
ROC Nee ne ss 157,797 822,406 980, 283 
a oe, eee 94,560 982,090 1,076,650 
AOR ts oleae ee 94,560 1,122,560 1,217,120 
Se ei ae ee 94,560 1,389,415 1,483,075 
GE ae 20,912 1,679,176 1,700,088 
CTA, See Sean ee 20,912 1,729,002 1,749,074 


United States Mint at about $0.27; in October, 1920, at $0.1775. At 
the close of 1921, sight drafts on Brazil were selling at $0.12 3/4 per 
paper milreis. Brazilian exchange has been at a discount for many 
years past, owing to the country’s system of inconvertible paper 
money. Even the favorable balance of trade which she had during 
the years of the World War was not sufficient to bring her exchange 
to par, and when her balance became unfavorable, the milreis sank 
to still lower levels. Exporters to Brazil usually draw in dollars or in 
sterling so as to avoid the uncertainties of exchange fluctuations. 

Chile. Chile’ presents the peculiar instance of a country which 
could retire all of its inconvertible paper money and place itself per- 
manently on a gold basis if it so desired; but the agricultural and min- 
ing interests demand the retention of depreciated currency and depre- 
ciated exchanges, and so the date of final redemption has again and 
again been postponed. ‘These interests are vitally concerned with 
the exportation of goods. Goods are sold abroad for gold, and the 
gold thus obtained is converted at a profit into the depreciated paper 
money with which to meet domestic expenses. 

The standard monetary unit of Chile is the gold peso of 0.54918 
grams of pure gold, with a par value of $0.365 in terms of our money. 
Practically all of Chile’s circulation is composed of inconvertible paper 
pesos, which have no par in American dollars, but which are usually 
quoted as being worth from $0.18 to $0.22. Approximately 226,000,- 
000 paper pesos were in circulation in March, 1920. A Conversion 


1Cf. Federal Reserve Bulletin, October, 1920, 1052-1061, May 1921, pp. 572-8. 


474 DOMESTIC AND FOREIGN EXCHANGE 


Fund of gold was established by the law of 1909 ! and on October 31, 
Ig19, it contained a sufficient amount of gold to retire all the paper 
money outstanding and to leave the government a surplus of about 
19,000,000 pesos. As stated above, it is the opposition of the mining 
and agricultural interests that has thus far prevented redemption 
taking place.” Because of the irredeemable character of the paper 
money, it is subject to fluctuations of from two to three per cent a day 
or from five to fifteen per cent a month. “These fluctuations in value 
give rise to extensive speculation, which in turn tends to aggravate 
still further the exchange situation.” * It is not uncommon for a bus- 
iness man to deposit money with his bank in terms of dollars or ster- 
ling, and to issue checks against his account in terms of dollars or 
sterling respectively, so that the Chileans have in circulation not 
only their own inconvertible paper money and checks drawn in its 
terms, but also checks drawn in terms of dollars and pounds sterling. 

Similar extensive fluctuations characterize the exchanges. The 
highest quotation for the month of August, 1914, was $0.1667 per 
peso. It rose rapidly and reached $0.3351 in June, 1918, but gradu- 
ally declined, closing in 1921 at $0.1063. 

European Nations since 1914. With the outbreak of the World 
War in August, 1914, economists and financiers waited expectantly to 
see whether or not the battling nations would show that they had 
learned from past experiences as to the disastrous results following a 
resort to the printing press as a means of meeting unusual expenditures. 
Hardly had the call to arms been sounded when even England, which 
of all nations had stood for decades as the advocate of sound financial 
and monetary ideals, joined the rest of the belligerents in the mad 
rush to issue paper money. Some of the nations were frank enough 
to admit that their paper money was inconvertible; others declared 
it to be legally convertible into gold but refused to make it such in 
practice. In fact, regardless of what the letter of the law may or may 
not have required relative to the maintenance of the gold standard, 
not one of the European belligerents attempted to retain the con- 
vertibility of its paper money; in time the neutral nations were forced 

1 From 1901 to 1914 this fund was held mostly in England and Germany; in 1914, 74,000,- 
ooo pesos in England and 30,000 pesos in Germany; in 1919, 66,667,000 pesos in the Chilean 
Treasury, 45,788,000 pesos in England, and 10,000 pesos in the United States. 

2 The last date set for actual redemption was December 31, 1921, but so far as I have 


been able to ascertain it has not occurred. 
3 Federal Reserve Bulletin, May, 1921, p. 575. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 475 


TABLE XXI 


CuRRENCY NOTES AND GOLD RESERVE IN 36 PRINCIPAL COUNTRIES OF 
THE WORLD IN 1914, 1918, I919, AND 1921 


(In Millions of Dollars U. S. Currency) 


1914 1918 IQIQ 1921 
Gold Notes Gold Notes Gold Notes Gold Notes 

PIGERMOS s «)/2\4p 6s ss $235 $428 $370 $404 $304 $513 $453 $578 
peahenr au ahs sh 29 48 85 255 86 260 a@ii2 G277 
Sohdem i 1 ey = page 254 464 53 7,206 52 10,099 { : ieee 
03 Pa (Os Be pe ey 180." (te ee eee 51 909 52 1,180 
raw eccs . « Aire eor25 175 38 560 44 582 24 a 554 
TUCO LER aero se 27 32 12 342. 9 476 7 615 
COREE TS Nato, orp «1's 155 210 201 468 203 534 190 447 
A MRM rete <li ale: a0 t 4 18 42 37 75 42 60 
WS la) 4 4 O ws Gark. 5 Io 25 16 
MUO RLS arc. ae ju tage dee a ater 4 @2,090 280 2,260 
DIGMIATICG. os oes 2a 20 42 51 II5 52 130 61 129 
AOL 6c e faery a4 5 2 4 6 5 10 es e 10 
REIS eta tae < o 4. 8 13 16 198 17 301 16 150 
IOS Re 7 24 8 213 8 205 8 272 
eet se ess Sic 806 =: 1,301 665 5,951 710 7,286 690 7,160 
MSOPIMIANY Pos os. is 208 692 621 4,127 266 7,501 260 24,300 
oy a 47 30 277 221 347 266 268 362 
MEATS MAA, ves be oe oa 167 521 156 2,721 157 3,628 161 4,110 
TIRE i ow bw «= 106 159 330 401 389 532 540 Sit 
UE Sh Sa en Bi Ae Ue See Mawirarg abe ed ee ees 15 880 
Netherlands....... 66 126 282 439 256 420 241 408 
1 TO a 4 335 56 t 63 1 87 t 
New Zealand....... 30 ime) 40 30 39 36 40 39 
PME RG Seats ore ake 14 33 33 I10 40 IIS 39 IOI 
ba hae le eee 20 t 28 34 32 25 a 30 a 34 
LeU ae ig UME eae oa Sol eee ads ah Gah «ins 2 1,620 5 36,414 
Otro al. yee oe 6 83 9 265 10 400 re) 667 
CARTE Pct ie Ohh i date 43 147 d 34 457 35 721 81 2,384 
POtINSInT Paz Oetwkc oid 7977 705 628 8,936 4 8,036 4 8,036 
OT Ee a ae 106 378 434 627 471 749 487 837 
PeETUER Ss cee aia 28 60 75 211 8I 194 75 166 
Switzerland........ 35 52 74 185 92 183 104 180 
U. Kingdom....... 195 140 521 2,040 504. 2,132 764 2,115 
| ae 1,023. 1.0505. 12,160 3,043. 2107 4,05I 2,044 3,037 
MOREA Dol. es 15 8 42 44 51 55 57 56 
Total of 36 countries 

OE A ae 4,682 7,553 7,380 40,350 6,759 55,104 8,184 123,445 
Ratio of gold to notes 63.3 18.4 14.7 6.7 


a 1920; b Figures of Austro-Hungarian Bank prior to 1920; figures for 1921 represent the 
Austrian Bank and the Hungarian Bank respectively, organized in 1920; ¢ Includes holdings 
abroad not separately stated; d Exclusive of gold holdings abroad; e 1919; f 1914 includes 
gold held abroad; in subsequent years exclusive of gold held abroad; g Includes Darlehn- 
skassenschein notes; # Includes bank and state issues; i No data; 7 No official data on 
Russian currency subsequent to October 1917. Bolshevik currency is stated in Associated 
Press dispatches from Moscow on October 30, 1921, at 5,750,000,000,000 rubles. 


476 DOMESTIC AND FOREIGN EXCHANGE 


into the same position. Gold disappeared from circulation. Paper 
in ever increasing amounts flooded the market places. The above 
table (Table X XI) prepared by Mr. O. P. Austin, Statistician of the 
National City Bank of New York, contains an excellent summary 
showing the extent of the expanding note issue of the principal coun- 
tries of the world from 1914 to 1920.1 

Mr. Austin has also compiled the following data (Table XXII) 
showing so far as ascertainable, the annual expansion of the total paper 
issues of the world, reduced to United States currency at the pre-war 
par of exchange. 


TABLE XXII 
WoRLD PAPER CURRENCY, 1914-1920 


Reduced to United States Currency at Pre-war Par 


LOTA so elvic hater aes $ 7,527,000,000 
TOES ot ON, civ a cae a eee 8,562,000,000 
TOTO. ae. ss eee eee 19,608 ,000,000 
LOL 7a oa ss 6 eee 32,747,000,000 
TOL Ges «seks 43,09Q1,000,000 
LOX Oars oe te ee 54,782,000,000 
TODOM at sae ee 81,596,000,000 


Gold reserves dwindled rapidly in proportion to the expanding note 
issues. To cite but a few examples: The gold reserves behind note 
issues of the following countries at the close of December, 1913, and 
at the close of June, 1921, were respectively: England, 118 per cent 
and 37 per cent; France, 73 per cent and 1o per cent; Italy, 58 per 
cent and 6 per cent; Germany, 56 per cent and 1.3 per cent. 

During the past year (1921) practically no progress has been made 
toward retiring any of this enormous amount of inflated currency, 
and in the case of some countries, notably Russia, Germany, Poland, 
Hungary, Roumania, Jugo-Slavia, and Austria, the amounts have 
been greatly increased.” 


1The Americas, November, 1920, p. 15. 
2 Decrease in Note Circulation of Various Countries between December, 1920, and 
September, 1921: 


Denmarle ies ae ae eet 13.6% Bank Notes 

Norway eh. hae os ee veer ates 13.6% 

Swetlen weiss See wae wes r1.5%0" de 

Tialvnauc ares os cane i he’ ae KR 

Netherlands-4-.45 ¢2ese ers 6.6% “ er Pete 18.4% State Notes 


United Kinedom veces cee. 6.2% Bank of England Notes; 14.7% State Notes 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 477 


The immediate effects of such inflation were as anticipated. Do- 
mestic prices soared to record levels as a result of currency inflation 
(Chart X), and the exchanges quickly fell to a discount (Chart XI)! 
and would have gone lower in the case of the allied countries had not 
successful efforts been made at stabilization. England artificially 





NF i918 «ISIS 1820s S21 


CHART X 


Wholesale commodity prices in the United States, 
England, France, and Italy (average prices in 
1913 = roo percent). From Monthly Review 
of Credit and Business Conditions in the Second 
Federal Reserve District, April 1, 1922, p. 6. 


pegged her rate at about 4.76 until March, 1919. The franc and lira 
were more or less closely tied to it, although not closely enough as to 
avoid certain adverse fluctuations. A premium on gold, however, 
did not appear, for reasons stated above” until opportunities for 


mrlmatin ote... PRO te 9% Bank Notes. . ....19.0% State Notes 
BVWILECTIANICL: dye’ cad secon 5.2% 

WPAVIOR se er 8 ss ous ste ee eee Pe Nao 

Path his b's). wd ee, ee £3 hid 

BMIARITE ote cd te. ch ee aa 89,8 Oy 


* Between Dec., 1920, and June, 1021. 
+ Between Dec., 1920, and March, 1021. 
From the Jndex monthly circular issued by the New York Trust Company, January, 1922, 


Dp. 4. 
1Cf. p. 483. 
Cf. p, 381. 


478 DOMESTIC AND FOREIGN EXCHANGE 


public trading were afforded. Immediately following the date of the 
“unpegging”’ of sterling and the removal of artificial restraints, sterling 
tumbled headlong and went to its lowest record level on February 4, 
1920, at 3.18 for bankers’ sight drafts.1 Francs followed, but did not 
reach their record low until November 11, 1920, at 0.05705.” Lire 
reached their lowest on December 28, 1920, at 0.0331.2 The mark 
likewise declined, but far more rapidly, and reached the lowest quota- 
tion to date (April, 1922) on March 27, 1922, at 0.0028 5/8.4 

With the unparalleled depreciation in exchange rates, a discussion 
was inevitable among economists as to the causes of such declines 
and also as to the advantages, if any, to be derived in foreign trade 
by a country whose exchange was at a pronounced discount in the 
world markets. The most widely accepted explanation of the unprec- 
edented decline from the pre-war mint parities has been a revised 
or extended statement of the theory advanced in 1861 by Viscount 
Goschen. In his volume on “The Theory of the Foreign Exchanges,” 
he states that “The bills on a given country fluctuate in value in pro- 
portion to the extent to which the prices of all purchasable articles— 
bullion included—are affected by the depreciation of the currency; 
in other words, in proportion to the discount of the paper money, or 
the premium on gold.’ The extent of the depreciation of the money 
of a country, i. e., its purchasing power, is shown most clearly by the 
price index numbers of that country. If prices double, the purchasing 
power of money is halved. To state the problem concretely, suppose 
to begin with, that we have two countries, the United States and Ger- 
many, in which, in normal times, through the workings of the ex- 
changes, the purchasing power of money is approximately the same. 
The exchange rates will remain practically at par, fluctuating nor- 
mally between the gold points. But say that one of these countries, 
Germany, under the stress of war conditions, issues a large amount of 
inconvertible paper money and as a result thereof prices increase to 
twice their former level. Gold goes toa premium. What of the ex- 
change rates? The value of the money of Germany has been halved. 
Will it command as much of the money of the United States as for- 
merly? According to the theory of Goschen and others, the German 

1Par $4.8665. 

2Par $.19295. 

3Par $.19295. 


4Par $0.23821. 
6’ Tenth ed., London, 1879, pp. 69-70. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 479 


exchanges will depreciate to an extent equal, or about equal, to the 
premium on gold or to what is the same thing, namely the discount 
on the paper money as shown by the higher price level. This theory 
merely restates what is known as “Lord King’s Law of Currency,” 
which is to the effect that “If a metallic and an inconvertible paper 
money are circulating together, and the market price of bullion ex- 
ceeds the Mint price, while the foreign exchanges have fallen below 
the specie point (i. e., the point at which it becomes profitable to ex- 
port specie), the paper currency is depreciated, and the difference 
between the market and the Mint price of bullion is the measure of 
that depreciation.” Applying the above theory to the position of 
sterling exchange in the United States—which can be done more 
easily than in the case of other countries because we have the data 
as to the gold premium readily available—it may be said that as soon 
as England opened her market to gold trading and a premium on gold 
appeared, the extent of that premium roughly, but not exactly, meas- 
ured the degree of depreciation of sterling in terms of dollars. Thus, 
for example, on December 30, 1920, the price of pure gold per ounce in 
the London market was £5 16s. 4d. The problem is to find the rate at 
which sterling exchange in New York should have stood on that day 
if the price for pure gold is normally £4 5s. and the par of exchange 
is $4.8665. The normal price of gold was 73 per cent of the price of 
gold on December 30, 1920. Seventy-three per cent of the par of 
exchange (4.8665) equals $3.5525, at which level sterling should have 
been on that day, considering the market price of gold in London. 
It stood, however, at $3.54, showing that the premium on gold roughly, 
but not exactly, determines the extent of the depreciation of a coun- 
try’s exchange in the world markets. The reason why it was not 
possible to gauge the discount of English exchange in this manner 
before 1919 is because trading in gold was prohibited and all ex- 
ports of that metal were completely controlled by the English govern- 
ment. 

Essentially, all transactions in foreign exchange involve a transfer of 
purchasing power. If we sell goods to England, we expect to receive 
in return certain funds which we can employ in purchasing goods, serv- 
ices, etc. If exchange on England declines 10 per cent, our drafts will 
sell for ro per cent less than they would if sterling were at par. To 
offset the decline, we will have to charge ro per cent more for our goods, 
which raises our prices for exports and makes our country a dear place 


480 DOMESTIC AND FOREIGN EXCHANGE 


in which to buy. Even though the English exchange may be greatly 
depreciated, it may be necessary for England to continue buying from 
us at our high price level because war conditions interfere with her 
ability to purchase in other markets, or because she can get the de- 
sired goods only from us. But if she is free to buy elsewhere, or to 
manufacture at home, she will do so. During the World War she had 
to buy from us. As a consequence her imports from the United States 
were in record amounts. As soon as the war was over, however, she 
sought other markets, or developed her own manufactures. Her 
imports from us decreased at an astonishing rate, while her exports 
to all countries greatly increased. We were too dear a market in which 
to buy, because she had to pay in her depreciated exchange or in gold 
which commanded a premium and which could not be exported except 
under government license. 

Gold exports from all of the European countries were (and in some 
instances still are) prohibited. Importers who had purchased goods 
from foreign countries could not export gold, and even if they had 
been permitted to do so, the extra premium demanded for the precious 
metal would have made it too costly. They did not want to pay in 
their own depreciated exchanges, so they began exporting goods in 
large quantities; thus building up their credits in foreign countries, 
against which they could draw exchange to pay their foreign obli- 
gations. From the standpoint of importers, foreign countries with a 
depreciated currency and exchange were good places in which to buy, 
because the internal price level of those countries had not risen so 
rapidly as their exchange rate had fallen. Soon, however, the im- 
porting countries began to fear the disastrous competition of the 
“cheap foreign-made goods,” and erected tariff walls of sufficient 
height for the protection of their industries.! Also, strange to say, 
the governments of the exporting countries became alarmed at the 


1The following note from the Index of January, 1922, aptly depicts the tariff situa- 
tion: ‘‘That the United States is only one of many countries that have considered or are 
putting into effect increased tariffs is shown by an examination of the reports of tariff 
changes the world over, published regularly in the official Journal of the Board of Trade 
of Great Britain. 

“In France last year there was a general revision of the tariff which advanced nearly 
all the coefficients by which the specific rates of 1913 are multiplied. This system of coeffi- 
cients is common in France. Each city, for example, has its standard prices of building 
materials. As costs of production increase these standard prices are multiplied by coeffi- 
cients. In the case of tariffs, the new coefficients by which the r9r3 rates are multiplied 
vary from 3 to 10. Belgium, likewise, employs this system of increasing tariffs, and the 
government announces that it is about to make a thorough revision of rates of duty. 

“Ttaly put into effect new and higher general customs tariffs last summer, the increases 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 481 


stream of goods flowing aboard. A shortage of commodities for home 
consumption was threatened, which, linked with an inflated currency, 
was causing internal prices to rise to still higher levels. Hence, ex- 
portation was curtailed in various ways by licenses, by apportion- 
ment or rationing of the volume of exports, by embargoes on the expor- 
tation of certain goods, and by export taxes. Instead of improving 
the situation so far as the exchanges were concerned, the effect was 
just the reverse of what was desired. With restrictions of one sort or 
another placed on the exports of both goods and gold, there was no 
other means available for strengthening the exchanges, and the ex- 
tent of the depreciation increased accordingly. 

The effect of such a condition on the foreign trade of the United 
States was adequately stated in the Federal Reserve Bulletin of Sep- 
tember, 1920: ! 


“Those countries whose currency is depreciated in terms of that of others 
presumably find it more costly to buy goods in countries where rates are 
high, while on the other hand the export trade with those countries whose 
exchange rates are low is subject to the difficulty of obtaining settlement 
from customers, while again competitive exporters in low-exchange countries 
are temporarily aided in selling their goods in neutral markets. This is a 
situation which the United States has been obliged continuously to meet 
for some time past. Inflation and uncertainty in the currency and banking 
systems of different countries and embargoes on the exportation of gold 
tend to aggravate such instability of exchange, while the recurring neces- 
sity of meeting maturities in international indebtedness likewise tends to 
make conditions more difficult.” 


Because of the advantages that were likely and expected to accrue 


being intended to compensate for higher cost of production in Italy as compared with other 
industrial countries competing with her producers in the Italian market. In Italy, and 
also in Spain, there is a surtax which is intended to compensate for the varying exchange 
value of the currency. The value of the lira in New York is the basis for the application 
of this surtax in Italy, the tax being fixed every two weeks by the Ministry of Finance. 
Spain, where duties have been increased from 50 to 400 per cent in the past 14 months, 
determines the rate of surtax every month on the relation of her currency to the pound 
sterling. 

“Switzerland, Esthonia, Latvia, Lithuania and Sweden have also increased their tariffs, 
while Denmark and Finland are in process of revising their tariffs upward. 

“Tt is noteworthy that several divisions of the British Empire have surrendered to what 
appears to be a world-wide impulse toward the erection of tariff barriers. India largely 
increased her tariffs in 1921, and Australia, following new duties fixed in 1920, has made 
several increases in the past year. Canada is likewise planning higher tariffs. So is South 
Africa and New Zealand. In South America, Peru, Bolivia and Chile have increased their 
customs and other countries are, according to report, planning to do so. Japan increased 
her duties in 1920, and put into effect a further increase last year.’ 

1P. go5. 


482 DOMESTIC AND FOREIGN EXCHANGE 


to those exporting nations whose exchanges were at a discount in for- 
eign markets, many countries began to express fears of being swamped 
with foreign-made goods, especially those from Germany because the 
mark was so greatly below par. Attention became focused on a study 
of the relation between the price level within countries whose ex- 
changes were depreciated and the level of their exchanges in other 
countries; in other words, the comparative internal and external 
purchasing power of the currency of a country, or the “purchasing 
power parity” as distinguished from the “mint parity.” Gustav 
Cassel, the eminent Swedish economist, has led in the discussion of 
this “purchasing power parity” theory,’ although ably assisted by 
other European economists, notably Pigou of England,” Pantaleoni 
of Italy, and Bruins of Holland. The theory has been well and briefly 
stated by Reginald McKenna, Chairman of the London Joint City 
and Midland Bank, Ltd., in the following manner: “The ratio of 
exchange between any two countries is normally determined by the 
ratio of their general price levels.”’ Or as Cassel puts it, “When two 
currencies have been inflated, the new normal rate of exchange will 
be equal to the old rate, multiplied by the quotient between the de- 
grees of inflation of both countries,” the degree of inflation being 
measured by the price levels of the respective countries. He wisely 
adds, “There will, of course, always be fluctuations from this new 
normal rate, and in a period of transition these fluctuations are apt 
to be rather wide. But the rate calculated in the way indicated must 
be regarded as the new parity between the currencies. This parity 
may be called the purchasing power parity, as it is determined by the 
quotient of the purchasing power of the different currencies.” 

As may be inferred from the last sentence of Cassel’s statement, the 
method of computing the purchasing power parity, say, between Ger- 
many and the United States, is to find what percentage the price 
index number of the United States is of the price index number of 
Germany (1913 being taken as the base in all the late discussions), 
and then to multiply the resulting percentage by the par of exchange 
between the two countries. This gives the percentage depreciation 
of the purchasing power of the mark in terms of the dollar. 


1Cf. Annals of the American Academy of Political and Social Science, May, 1920, p. 259 
et seq.; Manchester Guardian Commercial, October 27, 1921; Economic Journal (England), 
December, 1918, pp. 413-415, December, 1919, pp. 492-406. 

2Cf. Economic Journal (England), December, 1920, pp. 460-472. 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 483 


The accompanying chart (Chart XI) prepared by the New York 
Trust Co.,' shows the increase in the commodity price indices and the 
decrease in the New York quotations of exchange on England, France, 
Italy, and Germany. More detailed comparison of the same data 


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CHART XI 


Commodity price indices and New York exchange rates on 
England, France, Italy, and Germany 


for these countries has been made by the Federal Reserve Bank of 
New York, and the results are shown on Chart XII, in which the par 
line represents the value of the dollar, while the exchange rate and 
the purchasing power of foreign monies are plotted as percentage 
depreciation below the full value of the dollar. 

1 Index, December, 1921, p. 5. 


484 DOMESTIC AND FOREIGN EXCHANGE 


The charts disclose the fact that before the free movement of the 
exchanges began, i. e., before the “unpegging” occurred, there was 


PERCENT. 
DEPRECIATION 
° 





~ git 1918 1919 920 192I 


CHART XII 


Purchasing power parity of sterling, francs, lire and 
marks, 1917-1921. Adapted from charts appear- 
ing in M onthly Review of Credit and Business Condi- 
tions in the Second Federal Reserve District, May 1, 
and August 1, 1921 
but slight correlation between the rates of exchange and the purchasing 
power parities. Exchange rates did not decline so rapidly as price 
inflation developed. But after “the exchanges were ‘unpegged,’ de- 
preciation in exchange and depreciation in purchasing power moved 


EXCHANGE WITH COUNTRIES HAVING OTHER STANDARDS 48 5 


in the same general direction. It is notable, however, that since the 
early part of 1919 exchanges have been constantly lower than relative 
purchasing power. The most important factor in this difference has 
undoubtedly been the constant balance of indebtedness against the 
European countries and in favor of the United States. A further 
factor has been the uncertainty of the political situation in Europe. 
In the last few months there has been a distinct tendency for exchanges 
to rise nearer to the purchasing power levels.” } 

In commenting upon the purchasing power parity of the mark, 
the Index” of the New York Trust Company states that a study of the 
situation during 1920 and 1021 “‘ discloses a wide difference in external 
and internal values, with the internal value of the mark from 59 per 
cent to 288 per cent higher than the external value. Even here, how- 
ever, it should be noted that given a period of stabilization the two 
values tend to become equal. From November, 1920, to May, 1921, 
the exchange value of the mark was comparatively stable, and the 
external and internal values were reduced from a difference of 135 
per cent to one of only 59 per cent. Beginning at about the latter 
date, however, a violent decline in exchange value took place, and 
the difference increased to 236 per cent in November, 1921.” 

In presenting the theory of purchasing power parity, the fact must 
not be overlooked that the exchange market is the most sensitive 
market in the world, and is influenced by certain factors long before 
the prices of a country may be affected. To cite but one instance: 
Prices in Norway had closely paralleled those of Sweden during the 
early months of 1920 but rose sharply above them after April, 1920. 
A sharp decline in Norwegian exchange as measured in Swedish money 
began in March and except for a slight rally in April continued to de- 
cline for several months. The advance in commodity prices, however, 
occurred “two months later than the beginning of the decline in Nor- 
wegian exchange, attributable to the fact that the exchange market 
is the more sensitive one and reflects underlying changes sooner than 
commodity prices.” * During periods of relative stabilization, how- 
ever, the internal and external purchasing power of a currency tend 
to become equal. In applying this principle, one must be careful to 


1 Monthly Review of Credit and Business Conditions in the Second Federal Reserve District, 
issued by the Federal Reserve Bank of New York, May 1, 1921, p. 5. 

2 December, 1921, p. 7. 

8 Federal Reserve Bulletin, December, 1921, p. 1431. 


486 DOMESTIC AND FOREIGN EXCHANGE 


do so in only the most general fashion, because, as has been said many 
times in this volume, theories in the field of the exchanges are capable 
only of general application and then only provided “other things re- 
main equal.” One may safely conclude, however, that “the ex- 
change value of one currency in terms of the other may or may not 
vary in accordance with the changes in their relative purchasing 
power. Ordinarily at any given time, in actual experience, the adjust- 
ment of the one value to the other is imperfect. If commercial trans- 
actions between the two countries constitute the determining factor, 
the correspondence will be close. Usually, however, varying appraisals 
of the future value of an inconvertible currency give rise to an element 
of speculation which tends, according to circumstances, either to 
widen or contract the spread between the two sets of values.” 4 

In normal times, any difference between the internal and external 
purchasing power of a currency is its own corrective, provided, of 
course, the various factors concerned are permitted to work fully and 
without restraint on the part of the government. When a difference 
does arise and cause exports to flow out of a country, the resulting 
drafts on the importing country force the exchange rate on the latter 
to fall, or, what amounts to the same thing, they increase the exchange 
rate in the importing country on the exporting country, thus bringing 
the exchange rate and the purchasing power parity into harmony 
with each other. | 

The numerous proposals that have been advanced looking toward 
the deflation of the currency, the resumption of the gold standard 
by the European nations, the lowering of prices, and the improve- 
ment or stabilization of the exchanges, will be discussed in Chapter 
- XIV. 


1Guaranty Survey, Sept. 26, 1921, published by the Guaranty Trust Company of New 
York. 


CHAPTER XIII 
INVESTMENT, SPECULATION, ARBITRAGE 


In earlier chapters some reference has been made to the financial 
returns secured by exchange dealers from certain phases of their bus- 
iness activities. It is clear, no doubt, that the small local dealer who 
sells exchange only through the agency of the large city wholesaler 
runs no risk and can count definitely on making a profit on his sales. 
He is quoted a “firm” rate by the exchange wholesaler, which may 
hold for a day or for a week, and which represents the fixed cost of 
exchange to him (the small retailer) for the designated period. He adds 
his profit to this quotation, the amount of the profit being gauged 
by what he thinks the traffic will bear, and charges his customer the 
resulting, and correspondingly higher, rate. The wholesaler is the 
one who runs the risks of losing through an increase in the rates at 
which he has to cover the sales of the small dealer, and during 1921-22, 
when market quotations on European countries stiffened noticeably, 
the losses suffered by the wholesaler were very great. Thus in the 
latter part of 1921, when francs rose sharply, several New York whole- 
salers lost more than $4,000,000 because they had to cover at higher 
rates than they had quoted their out-of-town correspondents. Simi- 
larly, orders for marks which had been quoted at 0.003614 had to be 
covered at over 0.0040. The practice of the New York wholesalers 
has been to issue a list of firm quotations based on the closing rates 
for the day, and to send this by mail to the country dealers, or by wire 
to the larger out-of-town dealers, where a similar process of distribu- 
tion takes place. Competition is very strong among the New York 
houses so that the margin of safety allowed is unusually small. These 
rates are supposed to hold for the following day. If, in the meantime, 
the market stiffens to any extent the margin is wiped out and the New 
York dealers lose by having to cover at higher rates. The seriousness 
of the situation and the heavy losses sustained finally induced these 
dealers, in December, 1921, to form an association with the object 
of eliminating some of the more outstanding abuses in connection 

487 


488 DOMESTIC AND FOREIGN EXCHANGE 


with exchange wholesaling. At a meeting on January 25, 1922, the 
following recommendations were adopted: 


“Exchange dealers should make a service charge of 25 cents for items 
amounting to less than $100 on which the profit at present is so small that 
such items are handled at an actual expense. It is also felt that the inland 
banks to whom the large New York dealers extend drawing facilities for 
foreign drafts and post remittances should bear part of the expense of the 
various supplies required, which in the past have been paid for entirely by 
the wholesale dealer. When rates are given out which are to be firm for 
an entire day it is felt that the unsettled market condition at present re- 
quires that adequate margin be maintained to provide against the sudden 
rises in exchange rates which are frequent, and that the limits up to which 
these drawings are to apply should be lowered. In quoting firm rates by 
telegraph it is suggested that as far as possible the offers be limited to a 
comparatively short space of time in order that the wholesale dealer may 
be partially protected. Speculative purchases should be discouraged. A 
charge of one-half of 1%, with a minimum of 50 cents, is suggested as fair 
and proper for drawings in small amounts on European points in United 
States dollars, which are to be paid at the rate of exchange prevailing on 
the day of payment. Uniform commissions to brokers should be arranged 
if possible through the Foreign Exchange Club by a joint agreement to be 
arrived at with the brokers themselves.” 4 


Even though these recommendations become effective, the exchange 
business of the small local dealer will still be free from any attendant 
risks, And so far as the proposed additional charges are concerned, 
they will merely be passed on to the customer by means of higher 
exchange rates. The suggested reforms would, however, materially 
protect the New York dealers against loss, but only in so far as their 
relations with the small dealers are concerned. 

Before taking up in detail a discussion of the innumerable risks that 
characterize the exchange business of a large dealer, and also the many 
methods to which he may resort in an endeavor to make his business 
profitable, it may not be amiss to mention the fact that at least in a 
few connections he is certain of his returns. When, for example, he 
charges a commission for the acceptance of drafts, or for the confirma- 
tion of a letter of credit, or for the collection of drafts, or for any other 
similar service, he is practically sure of receiving payment therefor. 
The risks attendant upon fluctuating exchange rates do not enter 
into such transactions. On the other hand, there is almost no other 


1 Commercial and Financial Chronicle, January 21, 1922. 


INVESTMENT, SPECULATION, ARBITRAGE 489 


phase of his business that is free from such uncertainties. His stock 
in trade is composed of funds kept abroad with various correspondents, 
against which he sells exchange at ever changing prices. Not only 
do his prices, i. e., the rates at which he sells exchange, vary from 
hour to hour and from day to day, but his costs are likewise a variable 
quantity. He has to create his foreign account by purchasing exchange 
which he sends abroad for collection and credit. The cost of such 
exchange fluctuates constantly. He may attempt to guard himself 
against losses through the purchase and sale of futures, but even so 
he still runs the chance of actually losing on such transactions. It is 
necessary, therefore, for the exchange dealer always to be on his guard, 
to watch the trend of the domestic and the foreign money markets 
most carefully, to shift his funds from center to center so as to take 
advantage of every opportunity of improving his position, to speculate 
on the course of the exchanges, to make investments in or by means 
of exchange when conditions appear to justify it, etc., etc. The three 
practices, however, to which he most frequently resorts are investment, 
arbitrage, and speculation. All three are to a certain extent specu- 
lative in character, so that it may be difficult at times for us to differ- 
entiate between them. 

In discussing the problem of how money may be made by exchange 
operations, the reader must keep clearly in mind some of the funda- 
mentals that have already been discussed, such, for example, as the 
fact that the exchange dealer is both a buyer and a seller, buying from 
and selling to both the public and other exchange dealers. He hopes 
to make a profit on his business, so he aims to buy low and to sell high. 
He hopes, not necessarily to make a profit on each transaction, but 
on his business over a stated length of time. Some large dealers figure 
profits every month; others only every half-year; while a few attempt 
to calculate profits daily, but merely for their own satisfaction, so as 
to see how matters are progressing. Also, the reader should not over- 
look the fact that the large exchange dealer buys and sells bills of ex- 
change of all sorts and description, running for different lengths of 
time and drawn on parties in practically all countries of the world, 
and that he has funds or accounts in a number of financial centers 
which he may use in his money making activities. Fortified by this 
brief summary of certain necessary fundamentals, let us first take up 
the subjects of investment and speculation in and by means of exchange 
operations. | 


490 DOMESTIC AND FOREIGN EXCHANGE 


INVESTMENT AND SPECULATION 


Some writers have preferred to consider only investment and 
speculation im the exchanges and have objected to discussing invest- 
ment and speculation in foreign stocks, bonds and other forms of 
property by means of the exchanges.! A certain amount of investment 
and speculation in the securities of foreign countries has always taken 
place, and future years will see American financiers even more active 
in this field than has been true in the past. It is well worth our while, 
therefore, to give some consideration to the possibilities of profit mak- 
ing in this connection as well as to the more customarily discussed 
methods of investing and speculating in the exchanges. 

Investment is the act of laying out money productively. The very 
word itself connotes the expectancy of a return greater than the sum 
invested. An investment may be made for a day or for a year, in 
short for any length of time, although in ordinary conversation, when 
one speaks of having made an investment, the inference is, strangely 
enough, that the investor intends to retain title to the property for a 
considerable length of time so as to receive a number of periodical re- 
turns thereon. All investments in foreign exchange, no matter what 
their nature, are speculative in character because of the uncertainty of 
the investor receiving profits or interest at stated periods of expectancy 
or of being paid his principal at the maturity of the investment. One 
may be arbitrary, however, and say that when the risk is great the 
transaction is a speculation, and that when slight it is an investment, 
or that when one buys hoping to sell within a very short time it is a 
speculation, while if one buys with the idea of keeping the funds tied 
up in the property for at least several months it is an investment. 
Personally, however, I am inclined to class both groups of transactions 
as speculative because they contain an element of uncertainty, owing 
to the fluctuations of the exchange rate, that is greater than is the 
case when funds are invested in domestic channels. Nevertheless, I 
shall make no effort to differentiate between investment and specu- 
lation in the present discussion.” 


1‘‘Sometimes the remittance of funds to a foreign country to be put out there in the 
purchase of bonds or notes, or in the making of short-term loans or advances, is referred 
to as an investment in foreign exchange. It is true . . . there is here . . . a chance taken 
with respect to the rate of conversion of the recovered foreign funds back into home money; 
but there is not technically, and properly speaking, an investment in foreign exchange.” 
Whitaker, op. cit., p. 345. 

2H. N. Laurie, Economist for the American Mining Congress, declared before the Com- 
mittee on Banking and Currency of the House of Representatives (Hearings on Bill H. R. 


INVESTMENT, SPECULATION, ARBITRAGE 491 


Bankers buy at “buying” rates and sell at “selling” rates. The 
difference is supposed to net them a profit. By buying large amounts 
they are able to buy more cheaply, and by selling small amounts to 
their customers they are able to charge a little higher rate than for 
large sums. 

The large dealers in exchange are continually buying sight drafts 
and long bills on foreign centers, and sending them abroad so as to 
build up their exchange accounts deposited with banks in other finan- 
cial centers. A New York dealer may, for example, on May 1 buy 
£50,000 of sight drafts on London firms or banks, when the rate is 4.85, 
at a total cost of $242,500. The drafts reach London, are paid, and 
the account of the New York dealer is increased by £50,000. Seven 
days later, if the exchange rates have risen, he may be able to sell sight 
drafts against his London account at 4.86. If he sells £50,000 of sight 
drafts at that rate, he receives a return of $243,000, which is $500 
in excess of the original outlay. If he can sell £50,000 of cables at 
4.865, he will receive $243,250 or $750 more than he originally invested. 
Banks frequently sell cables to customers and are compelled to pur- 
chase cables from other banks in order to cover. Being keen buyers 
and also large purchasers, they may be able to cover at a profit. New 
York bankers usually expect a return of about 15/100 of a cent per 
£ 1 (15 points) in selling cables against remittances of sight drafts, or 
a profit of $15.00 on every £10,000 sold.!. Of course the exchange 
dealer is not always able to buy and sell under such favorable condi- 
tions. He may have to sell at lower prices than the exchange cost him; 
or he may be able to sell only a small portion of his account at a favor- 
able rate; or if the market is dull, he may have to let his account lie 
dormant for a short time, earning only the deposit allowance rate of 
the foreign correspondent. 

If a bank has sold a large amount of sight drafts, and expects the 
rates to decline, it may wait until the last moment, just before the 
sight drafts reach their destination, and cover by the purchase of 
cables. If the sight drafts were sterling and had been sold at 4.86, and 
if seven days later cables had declined to 4.86, the bank would have 
had seven days’ use of the money received from the sale of the sight 
drafts before being compelled to pay it out for cables as cover. 


8404, p. 6) that ‘‘Exchange experts are of the opinion that from 50 to 75 per cent of the 
total value of all exchange transactions have no relation to the actual movement of com- 
modities; or, in other words, are purely speculative.” 

1 Escher, “‘Elements of Foreign Exchange,” p. 73. 


492 DOMESTIC AND FOREIGN EXCHANGE 


The bulk of exchange business is carried on by the purchase of sixty 
and ninety day documentary bills and the sale of cables or sight drafts 
against the accounts built up thereby. If, for instance, a merchant 
offers to sell to a banker a £10,000 ninety day draft when the sight 
rate in New York is 4.8655, and the London discount rate for three 
months bills is 4 per cent, the banker will calculate his price in the 
following manner: 








Sight. tates. sow pnb aegtalve teiake reece ane 4.8655 
O3 days discOunE at.497 wee cla e .04943 
SLAMD ta X,71/2005 tues ae .0024 
Proiit-and commission. .).2 oie ee .O1 
.06187 
4.80367 
Nearest: market quotation... 2s..iceues aie eee 4.8035 


In this calculation the discount is figured on the basis of 365 days to 
the year, which is the English basis of computation, and at 4.85 per 
pound, and is taken from the interest or discount tables used by the 
exchange dealers in such transactions. The expected profit of the 
buying bank and the commission of the London correspondent 
have been lumped together and placed at $0.01 per pound. Bankers 
usually calculate on a profit ranging from 1/8¢ to $0.02, depending 
upon circumstances. The correspondent’s commission is normally 
about 1/40 per cent. At the rate of 4.8035, the New York banker 
would pay $48,035 for the £10,000 ninety day documentary draft. 
If the draft is sent abroad for acceptance and immediate discount, the 
following results would be obtained if the discount rate still remained 
at 4 per cent: 








Discount on £10,000 at 4% for 93 days....... £rior- Ss, Aa. 
Stamp tax paid by correspondent and 

deducted from the proceeds............. S*. (OSs ten 
Commission of the correspondent (1/40%) 

likewise deducted: A: Waiwera 24 Bas 2 Ios. od. 

Total deductions myesache soccer ew £109” “SS—eade 

Face value of thesbillias sebeiaae cee tae £10,000 

Less deductions “er aaa eee ae 109.) s 8&s.-s 4d. 


Net: proceeds ixg.s Auhiitas Secindh aka ae Maat ee nee £9,890 11s. 8d. 


INVESTMENT, SPECULATION, ARBITRAGE 493 


Suppose that the banker sold sight drafts the same day or the next 
day after purchasing the ninety day bill, for the entire expected net 
proceeds and at the rate of 4.8655. He would receive $48,122.63 
from the sale, or a gain of $87.63 on the transaction. If the sight rate 
had advanced and he was able to sell sight drafts at the rate of 4.87, 
he would receive $48,167.13 from the sale, or a gain of $130.13 on the 
transaction. The expected returns of a banker on exchange operations 
of this character normally range from 1/20 per cent to 1/10 per cent, 
and under very favorable conditions from 1/4 per cent to 1/2 per cent. 
While the returns appear to be very small, it must be remembered 
that the banker has his funds invested but a very short time and that 
he turns over his capital frequently, thus netting on the basis of a 
year’s business a very fair return if all operations turn out as success- 
fully as the one described above, which, of course, is not the case. 

Instead of having the above bill discounted as soon as it has been 
accepted in London, the banker may decide to hold it until maturity. 
The facts of the operation would then appear as follows: 


Investment in go day bill at 4.8035 per £.... .$48,035.00 


Face value of draft at maturity in London... . £10,000 


PrenUCeSLAINy Lbke eee ee eee et fs SS o erOsr fOUs 
Deduct correspondent’s commission......... Sos. sO: 
INGer DIOCCCUS ye tae ie te eee he io: £09,992 10s. od. 


If, at the maturity of the bill, the sight rate on London is still at 4.8655 
and the banker is able at that time to sell sight drafts to an amount 
equal to the above net proceeds (£9,992 10s.), he will receive there- 
from the sum of $48,618.51, or a gain of $583.51 on $48,035 invested 
for 93 days. Had he been able to sell at 4.87, he would then have 
received $48,663.47, or a gain of $628.47. A high discount rate in 
foreign centers induces American bankers to buy and hold long bills 
until maturity in order to receive the high discount rate thereon; but a 
decrease in the discount rate causes them to discount the long bills 
held by their foreign correspondents and to discount immediately 
all bills purchased while the discount rate is low. It is a common 
saying that when high discount rates prevail in foreign centers Ameri- 
can bankers buy exchange for investment and not for discount. 
Should the London rate of discount or the New York money rates 
change during the usance of the bill, the banker instead of holding 


494. DOMESTIC AND FOREIGN EXCHANGE 


the bill until maturity might possibly have it discounted so as to take 
advantage of the changed money rates. Taking the same data as 
above, let the London discount rate at the time of the purchase of the 
_bill be 4 per cent, the usance of the bill 90 days, its amount £10,000, 
the sight rate on London 4.8655, and the New York money rate lower 
than the London rate. The purchase price of the bill would be, as 
above, $48,035. It is sent abroad and accepted, the correspondent 
being given orders to hold the bill until maturity or until notified to 
discount it. At the end of the first month, if the discount rate in 
London falls to 2 per cent, and the New York money market stiffens 
so that it becomes profitable to employ the funds at home, the London 
correspondent will be advised to sell (discount) the acceptance in the 
open market. The facts of the case will then appear as follows: 


Face value’of acceptance £10,000. 4.0 wie cota pee oe £10,000 
Usance go days (plus three days grace) 
Draft has run for 30 days with 63 days remaining 
before maturity. 
Rate of discount, 2%. 
Discount on £10,000 at 2% for 


Oailavs! bath mune me obec «eae £34. .108.. 5d 
Btambitan (1/200, joey a. ee Cae Osu OU 
Commission to correspondent (1/40%). 2 tos. od. 
DCGUCHOnS. tae PRE oo ae cao) eos eu 42. -08; (Mea: 
Net: proceeds 0 i is seis y eiea eae oie ke cee a £0,057 LOSauayae 


If the sight rate on London has remained at 4.8655 and the banker 
is able to sell sight drafts for the entire amount of his net proceeds, 
he will receive $48,451.72 from his sales, or a gain of $416.72. If the 
sight rate has advanced to 4.87 he will receive $48,496.63, or a gain 
of $461.63. 

In any of the examples given, instead of selling only sight drafts, 
the banker may sell all cables, or some cables and some sight drafts, 
thus netting a slightly larger return. In discussing the sale of sight 
drafts on any foreign center against remittances of time drafts, the 
reader must remember that the exchange dealer can sell sight drafts 
on European centers from 7 to 10 days before the maturity dates of 
the bills that have been remitted, because it takes from 7 to 1o days 
for the sight drafts to reach their destination and be presented for 


payment. 


INVESTMENT, SPECULATION, ARBITRAGE 495 


As we have seen in earlier pages, exchange dealers keep closely in 
touch with the financial standing of the firms whose bills of exchange 
are offered for sale. If a firm does not have an excellent financial 
standing, or has incurred what the exchange dealer thinks is too great 
a liability on bills of exchange outstanding, the exchange dealer will 
pay a little lower rate for the bills of that particular firm than for the 
bills of a firm in prime condition. The exchange dealer takes a little 
greater risk than usual and pays a little less than the market rate 
for such bills, but if the transaction turns out satisfactorily and the 
bills are met at maturity, he will make a profit greater than usual 
because of his lower purchase rate. Or again a firm may have ac- 
quired a bad reputation through one of many causes, but may have 
subsequently put itself in good condition. The old reputation may 
cause its bills to sell for less, but the exchange dealer, having access 
to the firm’s financial statements, etc., may feel that it is a safe risk 
and be willing to purchase its bills at a rate about $0.02 less than that 
being paid for prime bills. When the bills in either of these last two 
cases have been realized on and their sums added to the foreign ac- 
count of the dealer, he can sell exchange against them at the going 
rates, and thus make an extra profit thereon. The same conditions 
exist as regards clean trade bills (bills drawn by one merchant against 
another without documents attached). Some bankers refuse to pur- 
chase bills of that character; those that do, pay a lower rate for them 
than for prime (first-class) documentary bills. When they mature 
and have been paid, the dealer is able, as in previous examples, to sell 
exchange against the accounts thus built up, and at the going market 
rates, thus making an extra profit. 

In handling documentary payment bills, which are not discountable 
in London (although discountable in Germany),! the dealer makes 
his gain on the lower rate that he pays for them. Moreover, while 
they are being held abroad, he may employ them as security for 
finance or loan bills, so that they are not “dead timber” on his hands 
in the meantime. Long experience with documentary payment bills 
enables the dealer to know approximately, because of the nature 
of the shipment, the practice of the drawees in taking up such bills, 
etc., about what proportion will be paid at sight, i. e., when presented 
for acceptance, what proportion at the end of five days, ten days, 
thirty days, etc. Having purchased £105,000 of such bills, he may ex- 

ECE, Dp. 1453 


496 DOMESTIC AND FOREIGN EXCHANGE 


pect £10,000 to be paid at sight, £15,000 at the end of five days, £30,- 
000 at the end of ten days, and £50,000 at the end of thirty days. 
Keeping these points in mind he may do one of two things. First: 
he may sell £10,000 sight drafts on his foreign account as soon as he 
has forwarded the documentary payment bills to his London corre- 
spondent. On the fifth day he may sell £15,000 of sight drafts, on 
the tenth day £30,000, etc., etc. If his surmise is correct, his account 
abroad will be credited with the above amounts before the sight drafts 
that he has sold are presented for payment. He buys at a low rate, 
because the bills are documentary payment bills, and sells at the 
higher sight rate. Second: on the other hand, he may, as before, sell 
the £10,000 sight drafts as soon as he has forwarded the payment bills. 
He may also sell £15,000 of drafts payable five days from sight, or 
twelve days from date. If the bills are five day sight bills they will 
have to be presented to the London correspondent for acceptance 
and will then run five days from that date. If they are twelve day 
date bills, they will not have to be accepted by the London corre- 
spondent, but will mature at the same time as the five day sight bills. 
He may also sell £30,000 of drafts payable ten days from sight or 
seventeen days from date, and £50,000 of drafts payable thirty days 
from sight or thirty-seven days from date. In all these instances, he is 
selling his own, a banker’s draft, against an account built up by means 
of documentary payment bills (trade bills). His drafts always sell 
for a higher rate than the price that he has to pay for the payment 
bills, thus netting him a profit. The date bills which he sells against 
the expected returns from his documentary payment bills may be 
purchased by importers and others who have debts to pay in foreign 
countries on certain dates, and who prefer, because of the money rates 
in the United States or because of the lower exchange rate at which 
they can procure such bills from the dealers, to invest their funds 
therein. Or they may be purchased by bankers as a form of invest- 
ment. They are sold at a lower rate than sight bills and, if the market 
appears likely to stiffen with a possibility of exchange rates rising, the 
bankers will purchase the date bills, hold them until within about 
five or seven days of maturity, and then sell them to other exchange 
dealers at the higher sight rate. By holding them until that time, 
the date bills have become practically the same as sight bills, because 
they will then be payable as soon as they can reach London. 
Speculation on the trend of the rate of exchange is ever present and 


INVESTMENT, SPECULATION, ARBITRAGE 497 


plays a part in all transactions, no matter what may be their nature. 
But the greater portion of all speculative investments, if we may 
technically use such a term, occurs in other ways than those that have 
been mentioned. A banker may feel that the trend of the market is 
downward, and that, say in five days, the cable rates will be consider- 
ably lower. He may sell “short”? on exchange and hope to cover by 
means of cables. Say that he sells sight drafts on his account in Lon- 
don when the sight rate is 4.8670, with cables at 4.8705. Five days 
later, owing to a weakening of the market, he covers by buying cables 
at 4.8640. He has not only had the use of the money involved for a 
period of five days, but he has been able to cover at $0.0030 less than 
he received for his sight drafts, which of course nets him an extra gain. 
If cables drop to 4.8670, he has the use of the money for the five days, 
although he is unable to make an extra profit through a lowered cable 
rate. If the cable rate remains at 4.8705, he will lose on the trans- 
action unless the money rates in New York are high enough to enable 
him to receive a sufficiently large return on the funds received from 
his sale of sight drafts to offset the high cable rate that he has to pay 
for cover. Going “short” means selling and hoping to buy later 
(to cover) at lower rates. The above transaction is of ordinary occur- 
rence in the exchange field. 

A similar situation arises in connection with the sale of “futures.” 
Suppose that an American importer is arranging for the purchase of 
goods from England. He will have to pay £10,000 three months 
hence to the foreign exporter. He fears that by that time the exchanges 
may have risen and thus be against him, so that he would actually 
have to pay more for his goods (i. e., for the drafts to pay for them) 
than he wishes to pay. He goes to his banker and arranges for the 
purchase of a future. The banker looks over the records for past 
years and sees that three months hence the rate for sight drafts is nor- 
mally around 4.865. The banker feels that the market will behave as 
usual, and therefore enters into a contract with the American im- 
porter to sell him a £10,000 sight draft on London at 4.8655, adding 
a slight amount to the expected rate as a margin of safety. The bank 
may require security of some sort if it feels that the customer is not a 
safe risk. Forward sales to customers are not always made for a fixed 
date because the customer frequently does not know exactly at what 
time the goods will arrive or his obligation fall due. Under such cir- 
cumstances it is the practice to sell a future for moderate amounts, 


498 DOMESTIC AND FOREIGN EXCHANGE 


deliverable at the customer’s option within a month or possibly within 
two months’ time. A higher exchange rate will be charged for an 
indefinite contract of this character than for a definite contract, be- 
cause of the necessity of the bank’s always being prepared to deliver, 
thus compelling it to carry an adequate balance abroad, and also be- 
cause of the impossibility of judging the range of exchange fluctuations 
over an indefinite period of a month or two. 

To revert to our example: three months pass and the American 
importer goes to his bank and pays $48,655 for the £10,000 sight 
draft. He has safeguarded himself against a higher rate by having 
purchased the “future.” But on the other hand, he will actually 
lose on the transaction if the market rate for sight bills has fallen, say, 
to 4.8580. In other words, had he, himself, taken the risk and waited 
until the day of payment, he could have obtained his £10,000 draft 
for $48,580, or $75 less than called for by his forward contract. The 
situation, however, is the same as that which exists in connection 
with any kind of property insurance. A business man may carry fire 
insurance on his property for many years, yet if he has no fires he re- 
ceives nothing for his outlay except the satisfaction of being protected 
against loss from fire. So it is with the importer who buys a future. 
He may possibly be able to get his exchange at a lower price if he waits 
and takes chances on the market quotation, but he prefers to play 
safe and base his business deal on a certain rate of exchange. On 
the other hand, of course, he gains if the market rate at the time of 
payment is actually higher than the rate called for by his forward 
contract. - 

Now what about the banker? If at the time the delivery has to be 
made the market rate is 4.8755, the banker stands to lose (unless he 
had protected himself by a “hedge” of some sort) because the ex- 
change that he has to deliver costs him, or is worth, $100 more than 
he receives for it. On the other hand, if the market rate drops to 4.85, 
he receives $150 more than it costs him to cover by purchasing sight 
exchange in the open market. Or if the market is evidencing a weaken- 
ing tendency he may prefer to use the $48,655 (which he receives from 
the importer) for five or six days, and then cover by cable at a rate that 
may yield him an extra profit. Thus, for the banker the transaction is 
also speculative in character. 

But it is possible in forward contract deals for even the banker to 
protect himself against possible losses from adverse exchange rates. 


INVESTMENT, SPECULATION, ARBITRAGE 499 


He, too, may purchase a future from another exchange dealer for 
delivery three months hence. Being a banker and knowing the inside 
of the market he will usually be able to purchase his future at a little 
lower price than that at which he sold his future to the importer. In 
fact, in quoting the future rate to the importer he may, before quoting 
a rate, obtain a forward quotation from another dealer, which he 
will use as a basis in quoting his forward rate of 4.8655. Or the banker 
may hedge by buying outright a £10,000 go day bill from another 
dealer. Whether he hedges by means of a future or by means of a 90 
day bill, he hopes that the rate which he pays for such a bill will be 
low enough to protect him against losses on his own future contract. 
The banker may also hedge by going into the market and buying 
£10,000 worth of 90 day payment or acceptance bills, which will 
mature and thus replenish his foreign account by £10,000 by the time 
that the forward contract draft is presented for payment in London. 
He will pay less for the 90 day acceptance and payment bills than for 
bankers’ go day bills. In each of these situations he will have pur- 
chased £10,000 of exchange which will become available as part of his 
exchange account go days hence. If the market rate rises to 4.8755, 
he will be able to sell £10,000 worth of drafts on his foreign account 
for $48,755 and thus offset his loss suffered through his obligation 
to deliver a £10,000 draft to his customer at the rate of 4.8655. On 
the other hand, if the market rate falls to 4.85, he may have to sell 
£10,000 worth of drafts at $48,500, taking a loss thereon that offsets 
his gain on the sale of the £10,000 draft to the customer for $48,655. 
Hedging thus at times enables the banker to “play safe” on forward 
contracts. | 

Bankers may also speculate on fluctuations of the rate by going 
“long” on exchange, 1. e., by buying or agreeing to buy in the present 
and hoping to sell in the future at a profit. We have already discussed 
certain phases of this method of procedure in connection with the pur- 
chase and sale of long bills, sight bills, and cables. But there remains 
one aspect of the matter that we have not as yet considered to any ex- 
tent, and which again, as in our last example, arises in connection 
with forward contracts. 

If an American exporter, for example, has been asked to quote 
prices to an English importing firm, he must be certain as to what his 
drafts will sell for so as to have a fixed basis upon which to calculate the 
prices of his goods. Therefore he gets his banker to quote him a for- 


500 DOMESTIC AND FOREIGN EXCHANGE 


ward rate for drafts covering exports to be shipped, say two months 
hence. This guarantees him a fixed return for his drafts regardless of 
where the rate stands in the market at the time the goods are ready 
for shipment. Or it may be that an American exporter has received 
an order for goods to be shipped to an English importer, and that he 
expects to have the shipment ready within two months’ time. To 
guard against a decline in the exchange rate he gets his banker to 
quote him a forward rate. Let us say that in both cases the draft is 
to be drawn for £10,000 and that the banker quotes a forward rate 
of 4.8655. In either case, when the exporter presents the draft to 
the banker, the latter pays $48,655 for it. 

Again, as was the case with the importer in the previous example, 
the exporter is buying protection. If the buying rate of exchange 
should fall below 4.8655 by the time he sells his draft, he gains by 
being able to market his draft at the higher price of 4.8655. But if it 
rises above 4.8655 he is bound to sell at that rate and therefore loses the 
opportunity of gaining because of the higher market rate. However, 
when he refuses to take the risks of exchange, and enters into a for- 
ward contract, he cannot expect to obtain protection and also the 
chance to profit by the existence of a market rate that is higher than 
his forward contract rate. 

Now as to the banker: He gains if the rate rises above 4.8655 and 
he loses if it falls below that figure. If it rises to 4.87 he is able to 
buy a £10,000 draft for $45 less than he would otherwise have to pay 
for it. If the buying rate falls to 4.85 he is paying $150 more than 
would have been the case had he not entered into the contract. Again 
must the reader be warned to remember that the banker’s buying 
rate for exchange in the open market (in the absence of a forward 
contract) is lower than his selling rate. Consequently,.even though 
the banker, with the open market buying rate at 4.85 pays $150 more 
for the draft than if he had not been bound by his forward contract, 
his actual selling rate for sight exchange may be sufficiently higher 
to offset this small loss on his forward purchase. } 

When a banker goes “long” on exchange, he may attempt to pro- 
tect himself by hedging just as he does when he goes “short” on 
exchange. When, as in the example just given, he agrees to purchase 
the £10,000 draft from the exporter two months hence at 4.8655, he 
may have been able to sell a £10,000 draft to another customer 
deliverable two months hence. Or before quoting a forward rate to the 


INVESTMENT, SPECULATION, ARBITRAGE 501 


exporter he may have called up another dealer and arranged to 
sell him a future for £10,000 at 4.87 deliverable two months hence, 
and then have used his rate of 4.87 as the basis for his quotation of 
4.8655 to the exporter. Or he may have gone into the market and 
sold 60 day bills on his London account at the prevailing market 
rate, because, if the rate should fall, he would be protected against 
loss, while if it should rise, he would only lose the chance of mak- 
ing greater profits by the sale of an equal sum of sight drafts two 
months hence at higher rates. His price for 60 day bills is supposed 
to yield him a profit at the market rate prevailing at the time of the 
sale. | 

The initiative in arranging a future contract may be taken by the 
banker himself as protection against losses arising out of purchases 
of long bills of any kind. He may, perhaps, have purchased a 60 day 
sterling bill which he sends abroad to be accepted and held until 
maturity. He can hedge or safeguard his interests by selling a future, 
payable 63 days hence, which will be the date on which the 60 day bill 
matures. He must make certain, however, that the rate that he gets 
for his 63 day future will be high enough to protect his investment 
in the 60 day bill that he has purchased. 

The uncertainties of the exchange market during and since the 
World War have made the resort to forward contracts more frequent, 
although many banks have refused to enter into them because of the 
possibilities of attendant losses. 

In normal times, forward contracts of any sort assist in stabilizing 
the rates of exchanges, just as grain or cotton futures or futures of 
any kind are of great service in stabilizing the prices of goods covered 
by such contracts. 

Somewhat similar to the future transactions just described is the 
practice, but lately begun in the United States although a long standing 
custom in European centers, of quoting forward discount rates on 
bank acceptances. Foreign banks and exporters are able to protect 
themselves against an unexpected increase in the discount rate by 
arranging with American bankers for a fixed discount rate 30, 60, 
or 9o days hence. American exporters and importers, and merchants 
engaged in domestic trade may likewise be accommodated if the 
financing of their business requires the discounting of commercial 
paper. The difference between the spot rate and the forward rate is 
usually determined by the money market conditions, and normally 


502 DOMESTIC AND FOREIGN EXCHANGE 


amounts to about 1/8 per cent per month of usance. Thus, if the 
spot discount rate (the rate for discounting bills immediately) is 6 per 
cent, the forward rate for 30 day contracts will be 6 1/8 per cent; for 
60 days, 6 1/4 per cent, etc. If the tendency of the money market is 
downward, the forward rate may actually be quoted lower than 
the spot rate. The banker in quoting a forward discount rate is specu- 
lating on the trend of the money market. If it weakens and money 
rates fall, he gains; if it stiffens and money rates rise, he loses the 
opportunity of making a greater gain through the charging of a higher 
discount rate. 

Forward contracts of any sort have but little to do with the greater 
part of the speculation that has been rampant during and since the 
World War. This speculation has been characterized by the rather 
general participation of the public in the purchase and sale of exchange 
and foreign securities to an extent never before known.! Indeed in 
many respects the exchange market has greatly resembled the stock 
market during its most active days. Purchases have been made al- 
most solely for resale at a hoped-for higher rate. Few people have 
entered the market with the desire to keep their funds invested for any 
length of time. Many of the deals have been of small extent; practi- 
cally all have represented what might be termed a ‘“‘gambler’s chance 
on a lucky turn of the market.” A very small number of the specu- 
lators have known any more about the intricacies of the exchange 
market than does the average person who “plays” the stock market 
in boom times. 

The majority of the deals have been and are represented by pur- 
chases of sight exchange on foreign countries. A person who desires 
to speculate in the exchanges goes to an exchange dealer and buys a 


1In commenting upon this situation Mr. F. J. Wade, President of the Mercantile Trust 
Company of St. Louis, declared that: 

“The trouble with European credit to-day is the gambling in foreign exchange, and 
there is not a man or woman or child in America, whether he be a street laborer or president 
of the biggest financial institution in America, with all the brains of all of the colleges in 
America, with all of the power of the United States, that can tell within $5,000,000,000 or 
$10,000,000,000 per annum of the gambling in foreign exchange. It is the only department 
of finance in this country that there is no check on. When [I tell you that I know that 
there was more than $18,000,000,000 of foreign exchange sold in New York last year, when 
the necessity for that exchange was less than $6,000,000,000—then you will see to what 
extent gambling is going on. Does that affect us? Why, they are playing with interna- 
tional exchange in Europe and America just like two boys playing football. They kick it 
over one moment and kick it back again the next. I think if we would only take care of 
foreign exchange gambling to protect its use for normal business then one-half of our battle 
would be over.”’ Commercial and Financial Chronicle, September 4, 1920. . 


INVESTMENT, SPECULATION, ARBITRAGE 503 


sight draft on a foreign bank. He holds it hoping for a rise in the ex- 
change rate. If a rise occurs, he sells the draft to his dealer or to an- 
other dealer and pockets the gains. Speculators have also purchased 
drafts on foreign banks, have sent those drafts abroad, and have 
opened up savings accounts upon which the foreign bank has paid its 
deposit allowance rate (interest on time deposits). Later, in case the 
exchange rate rises, the speculator has gained the interest on his 
foreign account as well as the profits arising from the sale of his ac- 
count at the higher exchange rate.! 

During the early years of the war speculation centered on the ruble. 
As it fell lower and lower, many persons purchased large sums of 
rubles hoping that they would soon return to par. On January, 22, 
1916, rubles were at a discount of 42.7 per cent. Had the ruble re- 
turned to par shortly after the conclusion of the war, investors would 
have reaped a considerable profit in addition to the possibility of 
receiving interest on their ruble accounts deposited with the banks 
upon which they had purchased their exchange. On the same day 
marks, lire, and francs were at a discount of 21.4 per cent, 27.3 per 
cent, and 13.2 per cent respectively. Similar opportunities were af- 
forded for speculation in these exchanges, but as the years passed the 
extent of the depreciation increased, except in the case of the franc. 
During week the ending March 17, 1917, the ruble, mark, lira, and 


1 Travelers have also had abundant opportunities to profit from exchange fluctuations. 
The foilowing article appearing in many papers during March, 1920, explains an inter- 
esting method whereby an American traveler increased his funds while traveling in Europe. 


“LONDON, March 6.—An enterprising traveler has demonstrated by actual ex- 
perience how it is possible for an American to see Europe for nothing, or, disregarding 
his expenses, multiply any sum he may carry with him many times en route. Here is 
the formula: 


“Leave America with say, about $350. Change it into 100 pounds, present exchange, 
in London. Cross to France and exchange into French silver coin (x pound equals 
42 francs), and you have 4,200 French francs. Smuggle these coins into Switzerland. 
Here they atta in twice the value they had in France, owing to the fact that the silver 
French franc is normal in Switzerland, but the paper French franc is worth but half 
its face value in exchange. Change the silver francs into Italian paper lire, then pass 
on into Italy and cash into Italian silver. You now have 21,690 Italian silver lire. 
Take these back into Switzerland you have 21,000 Swiss francs. Now purchase French 
paper money and you will receive for it 42,000 French francs. Return to France, 
there buy English notes and proceed to London with 1,000 pounds instead of the roo 
pounds you set out with. 

“Change these into American money at present exchange and you have about 
$3,500 instead of about $350 you possessed at the beginning of the journey. 

““Of course, you have to do a bit of smuggling and you have to pay your expenses, 
but anyway you make money. That is one of the present features of the exchange 
situation and the premium on silver.” 


504. DOMESTIC AND FOREIGN EXCHANGE 


franc were respectively at 44.7 per cent, 27.5 per cent, 33.9 per cent 
and 11.3 per cent discount. A year later (March 11, 1918), the rate of 
depreciation was 74.4 per cent for rubles, 41.8 per cent for lire, and 10.4 
per cent for francs; marks were no longer quoted. 

Some of the weakening influence was caused by speculators dump- 
ing their holdings on the market as the rates declined, taking very 
heavy losses in doing so, but the more important factors in the situation 
were those that have already been discussed in earlier pages. 

During the period of the war, and until March 19, 1910, sterling 
remained pegged at 2.2 per cent discount. After it was unpegged, 
however, it declined rapidly, reaching its lowest on February 4, 1920, 
at 3.18. Francs and lire likewise declined, francs reaching 0.05705 
on November 11, 1920, and lire, 0.0331 on December 28, 1920. Many 
astute speculators bought in heavily at those astoundingly low rates, 
and their purchases had a pronounced stiffening effect upon the market, 
although being but one of the many factors present in the situation 
at that time. Say that a buyer purchased £10,000 of sight sterling 
on February 4, 1920, at 3.18, it would have cost him $31,800. Had 
he sent the exchange to England and opened an account he would have 
received an interest return thereon, say 3 per cent, for the length of 
time that it was left intact. On March 4, 1922, the rate for sterling 
sight drafts was 4.40. Had he closed out his English account on that 
day at that rate he could have sold £10,623 16s. 5d. of exchange (£10,- 
ooo ++ accrued interest at 3 per cent for 759 days = £10,623 16s. 5d.) 
and have received a total return of $46,744.82 on his original invest- 
ment of $31,800, or a gain of $14,944.82. His investment had run for 
a period of 759 days and had brought a gain at the rate of 22.6 per cent 
per year. He could have made a slightly greater return had he sold 
cables, for the rate on that day stood at 4.41%. 

Had the speculator purchased francs at 0.05705 on November 11, 
1920, and have held them until March 4, 1922, when they were selling 
at o.og10, he would have made a profit of about 77 per cent on his 
investment during a period of 478 days, or at the rate of approximately 
58.7 per cent per year. Had he used them to establish an interest 
bearing account in a French bank, his interest returns on the same 
during the 478 days would have added considerably to his gains. Lire 
had risen to only 0.05260 by March 4, 1922, and did not offer such 
large speculative profits as did francs. 

Speculation in marks has been especially widespread and huge gains 


INVESTMENT, SPECULATION, ARBITRAGE 505 


as well as huge losses have been very common, even on short time in- 
vestments. On January 9, 1922, the rate for sight marks fluctuated 
around 0.0058. Had they been purchased on that day and sold on 
March 23 of that year, when the rate was at 0.0029, the speculator 
would have taken a loss of 50 per cent. .On the other hand, had 
marks been purchased at 0.0029 on March 23, 1922, and sold seven 
days later when the rate had risen to 0.003475, the speculator would 
have netted a gain of 13 per cent on a seven day investment, or at the 
rate of 677 per cent per year. 

Nearly all such speculative transactions have been put through 
by the purchase of sight drafts. Some people, however, have pre- 
ferred to buy the actual currency of foreign countries, such as the bank 
notes of England, France, Germany, or the paper money issued by 
the foreign governments. This practice is far less satisfactory than 
speculating by means of sight exchange or investment in foreign 
securities, because foreign currency usually commands a higher price 
than does foreign exchange or foreign bonds. It also has a much less 
active market. A bundle of 100,000 marks in bank notes would make 
a package about the size of a telephone directory of a large city like 
Chicago or New York. It costs more to transport foreign currency 
to the United States because of shipping and insurance charges. 
Foreign currency must therefore be sold for higher rates than foreign 
bonds or sight exchange. The risk entailed is also much greater, es- 
pecially if the currency comes from a country where it is greatly de- 
preciated, because one can never tell when a law may be passed chang- 
ing its legal tender qualities, its redemption value, etc. Such laws 
would necessarily greatly decrease its value. 

The following table presents the gains possible on foreign currency 
based on the rates charged therefor on May 3, 1922, and also on the 
assumption that the currency will return to par. Just how soon that 
happy condition of parity may come about, it is not possible even to 
prophesy, so that the probable yearly percentage returns on such in- 
vestments cannot even be approximated. 

That a large amount of foreign currency is held in the United States 
is evident from the advertisements appearing in newspapers and 
financial magazines and also from the great number of persons who 
visit the exchange dealers eager to buy or to sell. It has been estimated 
that about one-half of the total issue of German paper marks are in 


506 DOMESTIC AND FOREIGN EXCHANGE 


TABLE XXIII 


PRICES OF FOREIGN BANK AND CURRENCY NOTES AND PROFITS ON 
PURCHASES 
Profits Obtainable 
Percentage on Cost, 
Prices of Notes on — Provided Notes Return 


Country May 3, 1922 to Par 
ETARCe sees ater cee Cee toe ae .0g18 IIo 
Belotum eit es ore ae es .0840 130 
[tahoe Aa ee a ee Re .0537 263 
GTEECEYeiee ts chicane bea eee .0450 329 
GreateBritaine oe oi aah ee 4.4350 934 
Canadane aura Sy hee uwe e .9850 1% 
INOF WEVA Sin tein ae, a eas 0 . 1865 43 
SWRCEICS ea cig tele bie eee 2590 3% 
Denmarkiec ay lise ie see oe . 2128 26 
TLOUAN eae Gites ake ree Eamets 3840 aa 
SAL ase wie ank eo 8 ties Aer eee yisns 24 
CsEPMan Vahee coe eee ati wry .0035 6700 
AUSUIA te ce Mouton eae . 00012 160740 
Gzecho-plovakia Wea ecaiy weer .O195 890 


the hands of foreigners and that about one-third are held by Ameri- 


1 
cans. 

Another phase of post-war speculation in the exchanges has taken 
the form of investment in foreign securities, both government and 


1 Samuel Montagu and Company of London in their Weekly Reviewof Foreign Exchanges, 


February 9, 1922, quote the following from an article by Prof. Gustav Cassel appearing 


in the Norwegian Mercantile and Shipping Gazette: 


“Germany sells Marks by the milliard to foreign countries, but when the buyers 
of these Marks later on want to obtain German goods for them, Germany declares 
that she will not sell to purchasers at the prices ruling within the country itself, and 
this for the reason that the international value of the Mark has been reduced which 
has naturally been a consequence of their realizations of German Marks. 

““As the value of the Mark is ultimately based on the fact that it represents pur- 
chasing power in the home German market, the behaviour of Germany indicates an 
extremely arbitrary plundering of those who previously supported Germany by pur- 
chasing its Marks. 

“To this Germany may, of course, reply that it is in a position of need, and that 
it cannot possibly allow itself to be completely drained of goods, and that at all events, 
the pressure of the Entente forces it to sell continually new lots of Marks. By their 
efforts to secure protective customs against the undervalued Mark, foreign countries 
unite with Germany in this plundering of the unhappy holders of German Marks.” 
He concludes his article by characterizing Germany’s manipulations of the Mark as “the 


greatest swindle the world has ever seen.” 


INVESTMENT, SPECULATION, ARBITRAGE 5°07 


corporation. Foreign currency and sight drafts pay no interest, al- 
though some American banks have introduced the practice of selling 
sight drafts on foreign banks that bear 2 per cent interest, the holder 
of such exchange agreeing to give the exchange dealer at least thirty 
days’ notice of desire to sell and convert his investment into dollars. 
Foreign bonds have been especially attractive to investors because 
their prices not only fluctuate with the rate of exchange, but they pay 
a good rate of interest while being held. One can thus invest in foreign 
bonds and expect to retain them for some years while they increase 
in value and at the same time have the opportunity of speculating 
on the exchange fluctuations by using the interest returns. Most of 
these bonds are coupon bonds, interest and principal being payable 
to bearer If interest coupons are held for an increase in the exchange 
rate, and if the rate rises, say 50 per cent,—the holder is able to sell 
his coupons to an American banker or exchange dealer at a 50 per cent 
advance. On a 4 per cent bond he would thus obtain a return of 6 
per. cent. 

Those who invest in foreign bonds may do so either through Ameri- 
can or foreign houses. Almost all the investments made by the general 
public in the United States have been handled through American 
stock and bond firms or through banks, all of which in their turn pur- 
chase from foreign firms. American dealers may require the entire 
purchase price with the order, or a deposit of 25 per cent, the re- 
mainder being payable on the delivery of the securities, or an initial 
payment of 40 per cent and the balance in ten monthly installments 
including interest. Others are willing to sell on a margin of 33 1/3 per 
cent, the customer putting up 33 1/3 per cent of the purchase price 
and the dealer advancing the remaining 66 2/3 per cent as a time loan 
at interest. The commission of the broker is included in the price 
which he charges the customer. 

Investment in foreign bonds has afforded an excellent speculative 
opportunity for large profits, ranging from 50 per cent to 2,000 per 
cent, provided, of course, exchange rates on foreign countries again 
rise to normal levels and bonds are paid at maturity. Even though 
there be only a slight increase in exchange rates within the next few 
years, adequate profits may be obtained. Provided it takes five or 
ten years for the exchanges to reach par, there are still abundant 
opportunities for a gain of from 30 per cent to 4o per cent on certain 
of the bonds of our more dependable European countries and munic- 


508 DOMESTIC AND FOREIGN EXCHANGE 


ipalities, to say nothing of the possibilities of even larger gains on the 
stocks and bonds of corporations within those countries. Many who 
have invested in sterling, franc, and lira bonds have been able thus 
far to realize satisfactory profits not only on their coupons but also 
on the sale of the bonds themselves, although many have also had to 
take losses. As exchange rates rise or fall the value of foreign bonds 
fluctuates accordingly.} 

The foundations of many of the fortunes of England, France, Ger- 
many, and Holland were laid during and after our own Civil War 
when American exchange was at a considerable discount in Europe, 
the dollar at one time selling for $0.33 1/3 in England, and for $0.25 
in France. Investments in first-class American bonds were made by 
many foreigners at that time, and large profits were obtained as the 
dollar slowly advanced to par. 

To illustrate some of the more outstanding examples of how profits 
are possible,—always keeping in mind that the discussion is based 
upon the assumption that the foreign exchanges will ultimately re- 
cover—let us first take up some of the more evident cases. 

If a speculator purchases, say, 100,000 kronen worth of Czecho- 
Slovakian bonds when kronen are worth o.o1go, the investment will 
cost $1,900, which could be carried on a margin of 33 1/3 percent, or 
for about $635. If kronen advance 1/10 of a cent in a week or in a 
month, the profit would be approximately 15 per cent for that length 
of time. If the kronen return to par (0.2026) within a fairly reason- 
able time, say ten years, a good rate of return would still be obtained. 
Speculation in French bonds also offers an opportunity for large gains. 
If francs are quoted at 0.0810, and if the speculator purchases 100,000 
francs worth of French bonds on a 33 1/3 per cent margin at that rate, 
the investment will cost approximately $2,885. If the franc rises 4 
of a cent within a month’s time, the profit on the increase in the value 
of the bonds will be $500, or at the rate of 17 per cent on a thirty day 
investment or at the rate of about 204 per cent per year. In March, 


1 Not only have individuals been able to profit by the low exchange rates on European 
countries but some of the South American nations have likewise been able to reap similar 
profits in connection with the payment of outstanding European loans. In August, 1920, 
Bolivia placed a loan in the United States, the proceeds of which were used to liquidate 
the French loans made to her in r910 and 1913 amounting to 56,603,000 francs. At the 
normal rate of exchange that sum would have amounted to $10,924,079. Because of the 
low franc rate prevailing in New York in August, 1920, Bolivia was able to liquidate her 
1910 and 1913 French loans with approximately $6,000,000, leaving a balance of $4,000,000 
which she planned to use in the construction of certain railways. 


INVESTMENT, SPECULATION, ARBITRAGE 509 


1922, the French government 4’s of 1917 were quoted at $56 per 
1,000 francs; French Victory 5’s at $67 per 1,000 francs; 50 per cent 
Premium Loan of 1920 at $82 per 1,000 francs, as was also the French 
government’s 6 per cent Internal Loan of 1920.! At par these issues 
are worth $193, their value increasing as the franc exchange rate rises. 
If purchased at the above prices and held until par is attained, they 
would net the owner 264 per cent, 237 per cent, 224 per cent, and 224 
per cent, respectively. Even though it takes fifteen years for the franc 
to reach par, the yearly return would amount to approximately 15 
per cent. 

English government bonds have not offered the opportunities for 
such large gains because the pound sterling has remained consistently 
higher than the other exchanges. In November, 1921, the English 
National War Loan of 1927, bearing 5 per cent interest, was quoted 
at $403 per £100; the National War Loan of 1922, also a 5 per cent 
bond, at $411; the Funding 4 per cent issue at $291, and the 4 per cent 
Victory Bonds at $315, par in all cases being $487. If these bonds 
had been purchased at the above prices and if held until they reach 
par, the profits on the face value of the bonds would amount to 
20.8 per cent, 18.4 per cent, 67.3 per cent, and 54.6 per cent, respec- 
tively, in addition to the interest payments. If it should take five 
years from the date of purchase for the bonds to reach par, the per- 
centage of profit per year would amount to 4.1, 3.6, 13.4, and 10.9, 
respectively on the face value of the bonds in addition to the yearly 
interest yield. 

For many years before the World War it was the practice of Ameri- 
can corporations to market some issues of bonds, or at least a part of 
their issues, in the shape of sterling, franc, or mark loans, the interest 
and principal being redeemable at par at the holder’s option either in 
francs, pounds sterling, or marks, as the case might be, and at a fixed 
rate of conversion. Typical of such issues was that of the Chicago, 
Milwaukee and St. Paul’s 4 per cent European Loan, issued June 1, 
1910, and due June 1, 1925, redeemable at par at holder’s option in 
francs or pounds sterling on the basis of £19 15s. 6d. for 500 francs. 
The semi-annual interest coupons called for 1o francs or 7s. 10 3/4d. 
In 1920 these bonds were offered in lots of 5000 francs at $580. The 


1 These bonds had been quoted on December 6, 1920, at $41, $51.25, $59.50, and $59.75 
respectively. In the early days of November, 1921, they had been quoted at $47.25, $57.25, 
$65.25, and $68.25 respectively. 


510 DOMESTIC AND FOREIGN EXCHANGE 


following data compiled by a New York investment firm show the 
percentage of profit on the investment (in addition to the interest) 
on the basis of sterling being at any one of four mentioned rates of ex- 
change on the date of the maturity of the bonds: 


Profit on 5,000 francs 
Sterling Exchange Maturity Value of Bond invested at $580 


3.85 $751.34 Over 29% 
4.00 791.00 ao 
4.50 889.88 ‘yea 
4.8665 962.35 CGSee 


An added feature in the case of these bonds is that both interest 
coupons and the bonds themselves remain valid for ten years after 
their due date, thus permitting the holders to retain them and take 
advantage of more favorable rates of exchange. 

An actual transaction that took place during the week of Decem- 
ber 13, 1919, in connection with an auction sale of £20,000 Pennsyl- 
vania Railroad Consolidated Sterling 344 per cent bonds, illustrates 
the above principles. The low rate for sterling on the day of the sale 
was 3.88, yet the bidder bought in the bonds at the price of $663 per 
£200, or at the rate of 3.31% per £. These bonds mature in 1945, 
and the purchaser evidently figured that sterling would be back to 
normal by that time. If it is, he will receive a profit of 46 per cent, 
or at the rate of about 2 per cent per year on the face value of the 
bonds in addition to the interest payments. The value of the interest 
coupons will also fluctuate with the exchange rate. At 3% per cent 
the bonds bear £7 interest per year. With sterling at 3.50 per £, the 
interest would amount to $24.50 on an investment of $663, or at the 
rate of 3.7 per cent per year. With sterling respectively at 4.00, 4.50, 
and 4.8665, the percentage interest yield would be 4.22, 4.75, and 5.13.* 

An example showing another method of profiting through exchange 
transactions and investment in bonds, but this time through falling 
exchange rates, occurred shortly after the Armistice. Japanese yen 
were being quoted above par, i. e., at 5414 (54% cents per yen) or at 
the rate of 183.48 yen for $100. It was felt that Japanese exchange 
was bound to decline at least to par, possibly to the rate of 50 cents 
per yen (200 yen per $100). A certain United States government 
bond was being quoted at that time at $95. The exchange dealer 


2Commercial and Financial Chronicle, December 13, 1919, pp. 2216-17. 


INVESTMENT, SPECULATION, ARBITRAGE Sit 


advised his Japanese clients not to withdraw their dollar accounts 
from the United States but to invest them in this particular issue of 
bonds because it was thought that they would at least rise to $98 within 
twelve months’ time. Expected profits were calculated in the follow- 
ing manner: 








Bieomueine OF MyestMent. i. iis. ck cae eww ne ec. 183.48 yen 
#1008 year hence: (expected)... ......5.-i.000.- 200.00 * 

TTD a: OA Rng, a he ke 16.52 yen or 9.00% 
U. S. Government Bonds at time of investment. . . $95.00 
U. S. Government Bonds a year hence (expected).. 98.00 

[NTs WR Pete ga yh Scio oc dea ee Oe 3.00 or 3.15% 
Sererre tr tie DONS AL xeCIAte WE: ois vies sien « waiecie’ sats 4.25% 
Total expected yield on year’s investment..................0.. 16.4% 


Yen did decline as expected, but the bonds at the end of twelve months 
were at about the same quotation, so that the investment netted ap- 
proximately only 13 per cent instead of the anticipated 16.4 per cent. 

During the past few years Americans have been especially urged 
to purchase German bonds, particularly the bonds of German munic- 
ipalities, because of the possibilities of large future profits if the ex- 
change rate for the mark should improve. The following list of quota- 
tions of German municipal securities and their prices per tooo marks 
in January, 1922, needs no comment. The reader, in the light of the 
preceding discussion, will be able to calculate the percentage yield 
of profit should the mark return to normal. 


GERMAN MuNICIPAL BONDS, JANUARY, 1922 
Prices per 1000 Marks 


PRC g hat #206. 1 erp $4.75 
DSTCINO RMR hats. 4 5 oh cis a n= whe Gyo" 
CCOlOaT er mm te eli so. bane ene 6.00 
YT CSR CIM Meer ain, fa) xis: iy Feetears Chy Ay 
PUSSCHIOL UGE. o's. a als oe aay a5 
PART OL Uma oe oto. sc REY oh 7.50 
RIAIGWULP MER RMT); ooo Sih Aleta 6.00 
Miinichigewe ean ¢ eal et aati 6.25 
DICMICtE A Ais alk oe VRE 6.00 


512 DOMESTIC AND FOREIGN EXCHANGE 


Similar prices prevailed for the bonds of German corporations. All 
securities quoted have a par value of $238 per 1000 marks. 

From the above it can be seen that the exchange rate is the most 
important factor affecting the value of foreign bonds in the United 
States market. The value of bonds in the foreign markets may 
actually rise, and yet they may fall in the markets of the United States 
as a consequence of a decline in the exchange rate. During the week 
of July 24, 1920, for instance, the average London quotation for the 
British government’s 414 bonds rose from $377 to $379 as expressed 
in dollars at par of exchange, but the decline in the sterling rate in 
the United States from 3.91 to 3.80, caused this increase of $2 to be- 
come an actual decrease of $6 in the New York market where the 
price fell from $302 to $296. On the other hand, the prices of foreign 
bonds in the foreign market may remain stationary or may even de- 
cline, yet, through a rise in the exchange rates in the United States, 
the price of those bonds may increase in the United States. Thus 
from the first week in March, 1920, to the second week in April of the 
same year, the London prices of the British government’s 414 bonds 
fell from about $393 to $379 as measured in dollars at par of exchange, 
but because the sterling rate advanced in New York from 3.38 to 4.02, 
the value of those bonds in the New York market rose from about 
$274 to $313. 

Aside from the speculative phases of investment by Americans 
in foreign securities, there are other considerations that must not be 
overlooked in the discussion of this matter. Citizens of European 
countries have for centuries past invested heavily in the stocks and 
bonds of other lands; Americans have not. That “trade follows in- 
vestment”’ has been amply proven in the past, especially in the case 
of investments in countries that are primarily producers of raw mate- 
rials. Also, as Paul M. Warburg has well said, “ International security 
markets are healthy adjuncts of international discount markets; they 
are important equalizers of trade balances, and I trust we shall not 
neglect to provide this important part of Uncle Sam’s equipment for 
his new career as a world banker.” ! Foreign countries still owe us 
large sums of money. Because of our protective tariff we are prevent- 
ing them from paying us in goods. They have paid us in part in gold, 
but they cannot afford to send us much more without seriously crip- 
pling their internal credit structure. We already have on hand too 


1Journal of Commerce and Commercial Bulletin, April 9, 1919. 


INVESTMENT, SPECULATION, ARBITRAGE 513 


large a supply of that precious metal. One of the most commonly 
suggested methods of aiding in the adjustment of this international 
indebtedness is through our investment in foreign securities. Without 
doubt, we should create in our country a broad open market for 
foreign securities payable not only in dollars, but also in the currency 
of the country issuing the security. As Mr. Warburg has well said, 


“We should have international bonds rather than foreign bonds. While 
' for many years to come the home market for such securities may be of 
very little importance to us, we cannot foretell what the future may bring. 
We know, however, that for England it proved of the greatest value in 
her hour of need that she owned billions of foreign securities enjoying mar- 
kets outside the British Isles, while France suffered from the fact that her 
loans to foreign lands had been made in a special issue payable in francs, 
and having their exclusive market in Paris.” 


ARBITRAGE 


We need not in this chapter discuss again the possibility of profits 
or losses for the exchange dealer through the issuance of finance bills, 
or through his acting as a correspondent on joint account or on com- 
mission in floating currency, sterling, franc, or mark loans; nor need 
we again consider the profits or losses arising out of gold and silver 
shipments. Those matters have been rather fully dealt with in earlier 
chapters. There still remains, however, one other group of activities, 
engaged in only by the largest exchange dealers, whereby gains may 
be made by taking advantage of existing exchange rates (a) to shift 
funds from one country to another, thereby increasing the amount 
of funds available, or (b) to transfer funds to a point through two 
or more other points or centers more cheaply than by sending the 
funds direct to their final destination. This practice is known as 
“arbitrage” or “arbitraging.” 

Arbitrage in foreign exchange may be defined as “a calculation to 
determine, or an operation to profit by, variations in cost of the same 
currency in different markets.’’! For its successful operation, arbi- 
trage requires proper equipment and an expert knowledge of the 
exchange field. The equipment consists of free funds in various centers 
that can be readily moved from place to place, and cable information 
concerning the rates of exchange existing at any moment in the various 
markets. With funds and the needed information available, the ex- 


1Guaranty News,, August, 1920, p. 184. 


514 DOMESTIC AND FOREIGN EXCHANGE 


change dealer may take advantage of the best rates in a number of 
financial centers to transfer his funds in the cheapest manner, or to 
shift his funds from one place to another and make them grow as they 
go. To illustrate: The cable rates between New York and London 
may be high; between New York and Paris, normal; and between 
Paris and London, low. A New York banker who has funds to pay 
out in London can get them more cheaply in London by cabling his 
correspondent in Paris to purchase cables on London, than he could 
if he purchased sterling cables in New York at the prevailing high 
rate. This is one phase of what is known as “three point” arbitrage, 
because three points or centers are involved. “Four point” arbitrage 
is also possible and is sometimes resorted to by the more expert ar- 
bitragers. For example, cable rates between New York and London 
may be high, between New York and Paris, normal, between Paris 
and Berlin, low; between Berlin and London, low. The New York 
banker, instead of paying his bill in London by purchasing sterling 
cables, will cable his Paris correspondent to purchase a telegraphic 
transfer on Berlin, and will cable his Berlin correspondent to purchase 
a cable on London, thus getting his funds to London through Paris 
and Berlin (around three sides of a quadrilateral) more cheaply than 
by purchasing sterling cables in New York. At times “two point” 
arbitrage is possible, for instance, between New York and London. At 
a particular moment the rate in London on New York and the rate 
in New York on London may not be at exactly the same level. New 
York can then wire London to sell a cable on New York, and at the 
same time New York can sell a cable on London, and, because of the 
slight difference in the rates, a profit may be made. 

The above description may be clarified by a consideration of some 
concrete examples. In the case of “two point” arbitrage, say that 
on a certain day, the officer of a New York bank who is in charge 
of arbitraging operations and who is known as the “trader,” receives 
a wire from London that cables in London on New York are at 4.88. 
At that moment he finds that he can sell cables in New York on Lon- 
don at 4.885. He wires his London correspondent to sell $50,000 of 
cables, which, being done, adds £10,245 18s. od. to his London account. 
He then sells cables to the amount of £10,245 18s. od. at the rate of 
4.885 and receives therefor the sum of $50,061.23. Out of this amount 
he will have to pay the $50,000 covering the amount of cables sold by 
his London correspondent. His gain on the transaction will therefore 


INVESTMENT, SPECULATION, ARBITRAGE 515 


be $61.23, minus, of course, the cable charges and the commission, 
if any, of the London correspondent. 

Similar results could be obtained if purchases were made, instead of 
sales. With the rates reversed, i. e., cables in London at 4.885 and. 
in New York at 4.88, say that the New York trader cables his London 
correspondent to purchase $48,850 of cables on New York, while at 
the same time the New York trader purchases £10,000 of cables on 
London. In New York $48,800 is paid out for £10,000 worth of ster- 
ling cables, and in London £10,000 is paid out for $48,850 worth of 
dollar cables. The London account of the New York trader is bal- 
anced, but he receives $50 (minus cable charges and commission of 
correspondent) more in New York than he paid out. 

In two point arbitrage, New York buys on (remits to) London and 
London buys on (remits to) New York; or New York sells (draws) 
on London and London sells (draws) on New York. No other combi- 
nation is possible in two point arbitrage. 

Three point arbitrage is a little more difficult to understand because 
one more point or center is added. To illustrate such a transaction, 
say that the rate for sterling cablesin New York is 4.89, that the rate 
for franc cables in New York is 19.25, and that the rate for sterling 
cables in Paris is 25.22. To transfer £10,000 directly to London by 
cable would cost the New York trader $48,900. If he transfers it 
through Paris, he will find it much cheaper because the rates between 
both New York and Paris, and Paris and London are, in our example, 
below normal. The New York trader could, if he desired, merely wire 
his Paris correspondent to purchase a £10,000 cable on London and 
deduct 252,200 francs from his (the New York trader’s) account; but 
it is more probable that he would take advantage of the opportunity 
to make an extra gain by buying franc cables on Paris in New York 
and by having his Paris correspondent buy cables on London. The 
costs and gain to him from the latter method would be as follows: 


mama cables (i ASO. ee Ae die 5a so oldie. vcitn cla wep $48,900 
$48,900 @ 19.25 cents per franc will purchase...... 254,025.97 francs 
254,025.97 francs @ 25.22 francs per £ willpurchase £10,072 8s. 


By thus working around two sides of a triangle, the returns are greater 
by £72 8s. than if cables had been bought directly; or, to put the 
matter another way, it has cost the New York trader less to get £10,- 


516 DOMESTIC AND FOREIGN EXCHANGE 


ooo to London via Paris than it would had it been sent direct to Lon- 
don. It is possible, however, for the rates in Paris on New York to be 
such that the New York trader might wire Paris to draw on him, i. e., 
to sell cables on him, and then for the New York trader to buy ex- 
change on London with the proceeds. Or it is possible for the rate 
in London on Paris to be such that it might be advisable for London 
to sell exchange on Paris instead of having Paris remit the funds to 
London by cable. To transfer funds to London, therefore, we may 
have any one of the following combinations of operations: 


New York remits to Paris; Paris remits to London 
New York remits to Paris; London draws on Paris 
Paris draws on New York; Paris remits to London 
Paris draws on New York; London draws on Paris 


To reverse the process and transfer funds to Paris instead of to 
London, we may have any one of four similar combinations of oper- 
ations, as follows: 


New York remits to London; London remits to Paris 
New York remits to London; Paris draws on London 
London draws on New York; Paris draws on London 
London draws on New York; London remits to Paris 


Three point arbitrage operations may also be engaged in at times 
because the rates of exchange may be such that it is profitable to 
transfer funds around three sides of a triangle, and finally bring them 
back home as a larger amount. Using the same data as in the above 
example, suppose that, when the funds have reached London, the 
rate in London on New York is at a level where the funds can be re- 
turned to New York at an additional profit. If they are so returned, 
it is possible to have at least sixteen different combinations of oper- 
ations similar to those described above in our example where the funds 
were sent from New York to London through Paris, or from New York 
to Paris through London. There is no need of our listing them; the 
reader, if he desires to do so, may readily figure out the various com- 
binations. 

Four point arbitrage adds still another center to the transaction. 
Taking the data in the above examples of three point arbitrage and 
adding Berlin with mark cables in Paris at .81 (1 franc = .81 marks) 


INVESTMENT, SPECULATION, ARBITRAGE 517 


and sterling cables in Berlin at 20.5 (£ = 20.5 marks), we would have 
the following results: 
£10,000 in New York @ 4.89 will cost............ $48,900 
$48,900 with francs @ 10.25 will purchase......... 254,025.97 francs 
254,025.97 francs with marks at .81 will purchase. . . 205,761.03 marks 
205,761.03 marks with sterling at 20.5 will purchase. £10,0372s. 5d. 


Thus when the funds are sent to London via Paris and Berlin, they 
net £10,037 2s. 5d, but had they been sent from New York direct to 
London the $48,900 would have netted but £10,000. 

To add another possible step to the above illustration: Even 
though the New York rate on London is very high, the rate on New 
York in London may be at such a position when the funds reach Lon- 
don, after passing through Paris and Berlin, that they may be sent 
back to New York at a further profit. In an instance like this, the 
funds will have gone entirely around four sides of the quadrilateral. 

In the above examples the differences between the cable rates have 
been large, much larger than those that normally occur, but the funda- 
mental thing for the reader to grasp is the method by which such 
operations are put through by the exchange traders. 

While arbitraging by cable is the ideal practice, yet some arbitraging 
is done by means of other forms of exchange transactions. We have 
already mentioned the practice of sending gold to a foreign center 
and there using it to purchase exchange on a third country; also the 
remitting of exchange by cable to a second center and there using 
the funds to purchase gold to send to a third country. Arbitraging 
may also be carried on by means of sight bills and long bills, as is 
evident from our definition above, which was to the effect that arbi- 
trage is a “calculation to determine, or an operation to profit by, 
variations in cost of the same currency in different markets.” Say 
that a New York trader has to transfer $100,000 from New York to 
London. The exchange rates are as follows: 


PLOT ND Ca ese eeee EN Tac « ins a Hates tide hs Peete 4.88 
Sterling sigh tiem eesti sss. vecsia ey aae a es 4.8750 
LCR OCH Vmmmmrnors |. 5! ul te aaveue elu, 4.85 
Discount Tate ts ONCOIls «../..8 eens eo 3% 
TANG SIGHT Aer atete a ois. sas. baltetetr ces Rene .193 
VEST KK SIQU tee ee erent css, wise giat ce ak gots oie 238 
Palisa OM LAMCOHMSIPILd a... io sean tielt s ease. 25.20 


PATIS. OD NEWE OLE y SIRDG . .!. ai eleceity a scriw'e eusls 5-165 


518 DOMESTIC AND FOREIGN EXCHANGE 


Berlin on, New \York; sight) 1, ae ee ed 
Berlin‘on London, sight...) : swe hee eee 20.50 
Shanghai on New York, sight.............. 63 
Shanghaion Longon, Cable nn acne cee PX be Wee 


What will be the cheapest method for the trader to transfer the $100,- 
ooo to London? For the purpose of comparing the relative costs we 
have to reduce all calculations to the basis of the cost of sending a 


sight draft. 


(1a Cable-tos_ondonic se cee a are 


Loss of interest for seven 


days (Gh 2st eta 5 eee re 


(94 Sight-dratt to.London, so. ....0- 
(3) 60 day draft to London......... 
Plus 63 days interest @ 3%........ 


(4) Franc sight draft to Paris 
and Paris to London 


gx = 25:20 % -193 _ gy 36360 
I 


(5) Marks to Berlin, and 
Berlin to London 


= $4.879 


SX = 20.50 X .238 
I 


(6) Order Paris to draw on 
New York and remit to 





London 
25.20 

$x = ade 4.8789 
5.165 


(7) Order Berlin to draw on 
New York and remit to 





London 
20.50 
$X = ; = = 4.8693 


(8) Order Shanghai to draw on 
New York and cable to 


London 
240 X 63 
$X = ——— = $4.8774 


31 X 100 








..4.88 
ra OO2G 
4.8772 
sa leo dient su bestellen ee 4.8750 
Aces 
.O251 
4.8751 
SX teeihz 
£ = 25.20 francs 
1 franc = .193 
4.8636 
+ CREO oh 
£1 = 20.50 marks 
m = .238 
4.8790 
$x) = £1 
£1 = 25.20 francs 
5.165 francs = $1 
4.8789 
$X = £1 
£1 = 20.50 marks 
4.21 marks = $1 
4.8693 
SX = 51 
£1 = 246d. 


31d. (2s. 7d.) = 1 Shanghai tael 
100 Shanghai taels = $63 


4.8774 


INVESTMENT, SPECULATION, ARBITRAGE 519 


The cheapest method of making the transfer evidently will be to 
buy a sight draft on Paris and to have Paris purchase a sight draft 
on London. The above tabulation does not exhaust all the arbitrage 
operations that are possible between the above points, but it is suffi- 
cient to show the method and the principles involved. 

Traders watch exchange fluctuations most carefully in order to take 
advantage of surprisingly slight variations in the rates. They are 
constantly in touch by cable with those markets in which their banks 
have funds. New York is several hours behind the opening of the 
financial day in foreign centers, so that when the traders reach their 
desks in the morning they find at hand cable information giving them 
a picture of the financial situation abroad. The morning cables also 
bring them offers of exchange and bids for varying amounts of ex- 
change from foreign dealers. With these data as a basis the traders 
prepare their “parity sheet” for the day. The parity sheet contains 
a tabulation of the foreign discount rates, the exchange rates prevail- 
ing in foreign centers, and the trader’s rates for buying and selling 
various kinds of exchange (cables, sight, 30 day, etc.), all expressed in 
American money. It is really a guide sheet, and is of constant service 
to the trader as he buys and sells exchange throughout the day. 

The parity sheet has nothing to do with the mint par of exchange; 
it is concerned only with the commercial par, which is an entirely 
different matter. There can be a mint par only between those coun- 
tries that have the same monetary standard; but there are commercial 
parities between all countries. ‘The commercial parities are the 
relative values of foreign exchange on a certain day in United States 
dollars.” 1 If we have the New York rate on Paris and the Paris rate 
on London, what should be the correct New York rate on London? 
Or, to revert to our geometrical parlance, with two sides of the triangle 
given, how long should be the third side? If the rate that does exist 
is less than it should be, an opportunity is offered for an arbitrage 
operation. If the New York rate on Paris is 19.3, and the Paris rate 
on London is 25.22, the commercial parity between New York and 
London will be 4.86746. Working this out by chain rule the calcu- 
lation would be: $x = £1 

£1 = 25.22-francs 
1 franc = $. 193 


Ne 198 =$4.86746 


I 
1 Westerfield, R. B., op. ctt., p. 1176. 


520 DOMESTIC AND FOREIGN EXCHANGE 


‘If the New York rate on London is 4.865 and the London rate on 
Berlin is 20.46, the commercial parity of New York on Berlin will be 
$0.23778 and would be calculated as follows: 


$X = marks 
20.46 marks = £1 
£1 = $4.865 
.86 
20.46X I 


Commercial parities are calculated for cables, sight bills, and long bills. 
In the case of long bills, stamp taxes and the discount are deducted. 

As any of the rates change, a new commercial parity must be calcu- 
lated. Usually the trader does this mentally by means of certain 
short methods of calculation and without changing his parity sheet 
for the day. At times, however, a trader may have recourse to parity 
tables, which he himself may have constructed or which he may have 
at hand in printed form. All parity and arbitration tables in print at 
present are out of date because of our decision in 1920 to quote all 
foreign exchanges in terms of dollars and cents. The table below is a 
small portion of a parity table formerly used, showing the commercial 
parity between sterling, francs, and dollars on the old basis of quoting 
francs to the dollar: 


pie 25.18 25.19 25.20 25.21 
$I $1 $1 $x 
4.85 5.1918 5.1938 5.19059 5.1979 
4.8525 5.1891 Rotors 5.1932 5.1953 
4.855 5.1864 5.1885 5.1905 5.1926 
4.8575 5.1837 5.1858 5.1879 5.1900 
4.86 roTOls 5.1831 5.1852 5.1873 
4.8625 5.1784 “5.1805 5.1825 5.1846 
4.865 5-1758 5-1778 5.1799 5.1819 
4.8075 =) 5:1731* -“Sak752. 5.077 ame Salad 
Ey SUT7Ob atresia Sek 740 5.1766 


When the New York rate on London was 4.85 and the Paris rate on 
London was 25.18, the commercial parity of New York on Paris was 
5.1918. When the London rate on Paris was 25.19 and the Paris 
rate on New York was 5.1805, the New York parity on London was 
4.8625. When the New York rate on London was 4.87 and the New 


INVESTMENT, SPECULATION, ARBITRAGE 521 


York rate on Paris was 5.1725, the London parity on Paris was 
Len <a 

The above table, with our present method of quoting franc ex- 
change, would appear in part as follows: 


bi 25.18 25.10 25.20 25.21 
4.85 .192613 . 192536 . 192460 . 1923839 
4.8525 OG ia ey: .19263590 .192559 . 192483 
4.855 .192811 . 192735 . 192658 . 192582 
4.8575 .192QII . 192834 §I02757 . 192681 
4.86 . 193010 192933 . 192857 .192780 


In normal times, rates of exchange between countries cannot long 
remain out of line with one another. As soon as the market rates differ 
from the commercial parity, arbitraging begins. This creates a demand 
for or a supply of exchange on the center whose rates are out of line, 
and as a consequence of the resulting pressure they are forced back 
into place. Of course, arbitrage is only effective in readjusting the 
rates of exchange when the market is capable of being influenced 
by such operations. An extra issue of depreciated paper money, or 
some other similar matter, may completely wipe out or nullify any 
effect that an arbitrage operation might normally exert. 

Traders must know at any moment of the day just how their ac- 
counts stand with their foreign correspondents. For this purpose 
“position sheets,” or “positions,” are prepared by their clerks. These 
position sheets, one for cables and one for sight exchange, show the 
amount of exchange on deposit with each of the correspondents against 
which cables or sight drafts can be sold, and the dates on which addi- 
tional exchange is to become available or is to be paid out. Traders 
must be in possession of these data, otherwise they might overdraw 
on one correspondent or carry too large an account with another. As 
deposits are shifted from one center to another, or as exchange is 
bought or sold, the position sheets are changed accordingly. Some 
traders also keep what is called a “ Profit and loss position” which en- 
ables them to “determine daily the profit or loss on exchange trans- 
actions, and the conditions of the stock of exchange and the average 
cost. The demand or check rate is used as the basis of the calculations. 
The prices of all time bills purchased are brought up to the check rate 
by taking into consideration the discount, costs, and stamps. The 
prices of cables are brought down to the check rate by considering the 


DOMESTIC AND FOREIGN EXCHANGE 


522 


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INVESTMENT, SPECULATION, ARBITRAGE 523 


element of interest. After all purchases and sales for the day have 
been entered on the sheets and each price correctly determined, they 
are totaled and the average price for the whole is calculated. As the 
purchases and sales for the day are never exactly equal, it is necessary 
to make adjustments. If sales exceed purchases and there is sufficient 
exchange in stock to cover the excess sales, the excess is taken from 
stock at the stock price; if purchases exceed sales, the reverse process 
is performed.” } 

Traders not only buy and sell exchange, but at times find it to their 
advantage to “swap” exchange with one another. A trader with a 
large amount of sterling cables on hand may want to invest for a 
period of seven days the funds which they represent and may be will- 
ing to swap them for demand bills. The amounts exchanged are 
equal but the party that gets the cables pays the difference between 
the cable and the demand rates. Holding sight bills permits of specu- 
lation on the trend of the exchange rates during the succeeding seven 
days. During the World War British censorship made it difficult for 


American bankers with German names to carry on their foreign ex- “ 


change business. The presence of a German name on a draft or in 
connection with a cable delayed the passage of the same until expla- 
nation was forthcoming. Bankers who were on the “black list” 
swapped their cables and bills for the exchange of other bankers 
whose business was not subject to such interference. Bankers who 
undertook to negotiate these war-time swaps did so at a commission of 
about $7 on every £10,000 transaction. 

Traders also make up the lists of exchange rates which are used by 
their banks in dealing with their domestic correspondent banks, these 
lists as a rule being sent out daily by wire and by mail. 

The traders are busy men, as may be appreciated from the above 
description of some of their activities. In addition to their dealing 
with foreign markets, they also keep closely in touch with their own 
local market and with other traders. They make constant use of the 
telephone, the telegraph, and the cable. The accompanying picture 
of the traders’ room of the Guaranty Trust Company of New York 
shows thirty private line telephones, mounted on brackets. Some of 
these are connected directly with foreign exchange brokers, some with 
corporations that are large buyers or sellers of exchange, and some 
with other banks or with the branches of the Guaranty Trust Com- 


1 Westerfield, op. cit., p. 1182. 


me 


DOMESTIC AND FOREIGN EXCHANGE 





An Exchange Trader’s Room 


INVESTMENT, SPECULATION, ARBITRAGE 525 


pany. In addition there are switchboard connections through which 
the trader keeps in touch with the outside world and with the various 
departments of the bank. There are also four extra telephones for the 
personal use of the official in general charge of all trading operations. 

From what has been said above in this and in other chapters, the 
reader must not conclude that exchange transactions by banks and 
by others net only profits and never losses. Under normal conditions 
the returns to large exchange dealers are extremely small even where 
millions of doilars of exchange are handled per year. Competition 
keeps down the rates and prevents excessive gains. The Annalist of 
February 14, 1916, in commenting upon this matter stated: 


“It is reported that a trust company, whose turnover in the foreign 
exchange market last year rose into the billions, cleared so small a margin 
of profit that it was expressed as ‘per mill’ instead of ‘per cent.’ The direct 
purpose of a foreign exchange department in most banks is to facilitate 
business generally, in the way of increasing the number and size of deposits 
and in drawing to the institutions a greater clientele. It is natural for 
commercial houses with many remittances to make to other countries to 
do their banking with institutions which give them first-grade attention 
in exchange matters.” 


When exchange rates broke so unexpectedly in March, 1919, many 
of the large exchange dealers in the United States were caught un- 
prepared and suffered losses aggregating millions of dollars. Again, 
when silver declined so rapidly in 1920, many dealers who had invested 
heavily in silver or in the silver exchanges suffered similarly. There 
are also the constant chances of loss through the non-payment of 
commercial bills at maturity. In 1920, American banks that had 
purchased large amounts of commercial bills on firms in Cuba, India, 
and South America lost excessive sums when, due to the rapid decline 
in prices, those firms refused to accept or to pay the drafts covering 
goods that they had contracted for at higher prices. American ex- 
porting firms, under the circumstances, found themselves in financial 
difficulties and many went into bankruptcy, so that the banks that 
had purchased the drafts were unable to collect the full amount owing 
them. Protest fees, cable charges, commissions to correspondents, 
and various other costs also eat into the expected profits. Unlooked 
for and adverse movements in the rates frequently turn anticipated 
profits into unexpected losses. 


526 DOMESTIC AND FOREIGN EXCHANGE 


The individual who speculates or invests in the exchanges also runs 
great risks of taking losses rather than making profits. Exchange 
rates may move adversely at almost any moment. Many who pur- 
chased European exchange when it was starting on its downward path 
had to take heavy losses as it dropped lower and lower. Speculators 
in rubles and marks have been especially hard hit, while considerable 
losses have been incurred in francs, lire, and sterling. Investors in 
foreign bonds, especially national and municipal bonds, also run the 
additional risk of having such bonds repudiated or payments post- 
poned indefinitely. Novices in exchange transactions must ever 
appreciate the fact that great risks always accompany opportunities 
to reap large profits. 


EE 


ee 


CHAPTER XIV 
THE WORLD WAR AND THE EXCHANGES 


During the early months of 1914 the foreign exchange market fol- 
lowed its customary course with the exception that, owing to our un- 
favorable balance of trade, exchange rates on foreign countries were 
higher than usual. In May sterling touched the highest point reached 
since 1907 and a considerable sum of gold flowed to England. Gold 
shipments continued during June, approximately $47,000,000 being 
sent abroad, but principally to Paris. Added to our continuing un- 
favorable balance of trade were the heavy remittances of American 
corporations for July dividends and interest payments on foreign held 
American securities. Another element in the June movement was 
the fact that the Southern Pacific Railroad had $20,000,000 worth 
of notes maturing on June 15, and the Baltimore and Ohio Railroad 
had an equal amount maturing on July 1. These notes were payable 
in London at the holder’s option in gold or in sterling exchange at 
4.8614. As sterling exchange in June was approximately 2¢ higher 
than the designated rate of payment, many holders of the notes 
availed themselves of the option, preferring to take gold rather than 
the more expensive exchange. This action necessitated the transfer 
of a considerable sum of gold to London. As the gold was sent, ex- 
change was drawn against it, and decreased the sterling rate slightly. 
The failure of the H. B. Claflin Co. stiffened the local money market 
and aided in weakening exchange rates. Although bankers’ sterling 
sight bills had advanced from 4.8825 on June 1 to 4.8895 on June 12, 
they declined to 4.8755 on June 30. Early in July the pressure of 
finance bills and wheat bills weakened the market somewhat, but 
during the latter part of the month the crisis in Europe produced a 
state of affairs absolutely without parallel in the history of the world. 

On July 24 Austria sent her ultimatum to Serbia; war followed. 
All stock exchanges on both sides of the Atlantic closed between 
July 27 and July 31. The New York Stock Exchange had remained 
open for a few days longer than some of the European exchanges 


527 


528 DOMESTIC AND FOREIGN EXCHANGE 


with the result that liquidation went on at an astounding rate from 
all parts of the world, causing startling declines in security values. 
This was the first time that the Stock Exchange of New York had 
closed since 1873. The London Exchange had never before been 
closed. European security holders objected strenuously to the closing 
of the American exchanges because they had hoped to be able to sell, 
at least, in our markets. It is said that a considerable amount of the 
unloading of securities in New York was caused by the attempt of 
speculators, who had been carrying marginal accounts, to “get out 
from under” and to seek safety at the first sign of war. Financial 
institutions and commercial firms in all countries hastened to place 
their houses in order for the oncoming storm. Many of the more far- 
sighted European financiers appreciated the fact that a credit balance 
in the United States would be of the utmost assistance in transacting 
their affairs, both during and after the war, and opened accounts in 
New York. With exchange rates mounting by leaps and bounds, 
gold exports increased accordingly. During the last ten days of July, 
gold to the extent of approximately $44,350,000 left New York. By 
July 31, demand sterling had risen to 5.50 with cables at 6.35, and in 
the early days of August some cable transactions were put through 
for as high as 7.00. For thirty years before the war the highest and 
lowest rates for sterling cables had been 4.91 and 4.82, respectively. 
Throughout Europe panicky conditions of the worst sort prevailed. 
Financial and business relations were most hopelessly upset. The 
central banks immediately mobilized the gold holdings of their re- 
spective countries, refused to extend credit, and in every way made 
hurried preparations for the ensuing struggle, little appreciating how 
long it was to continue. Gold in France went to a premium before 
the end of July. On August 4, the Reichsbank was released from its 
obligation to pay its notes in gold. On November 23, the Bundesrat 
decreed that the buying or selling of German gold coin at a premium 
was a penal offense. The Bank of England, thinking that a European 
war was not possible, had been caught unprepared. Immediate re- 
course was had to the suspension of the Bank Act of 1844, under which 
it operates. This was accomplished by means of a note sent to the 
Bank by the Prime Minister and the Chancellor of the Exchequer 
on August 1, 1914, the formal suspension of the Act being decreed 
by Parliament five days later. England also followed the example 
of other European countries and declared a moratorium, thereby 


THE WORLD WAR AMD THE EXCHANGES 529 


postponing the payment of debts of certain kinds until a future date. 
The joint stock and private banks of England called in their loans and 
refused to renew American finance bills, which had been issued, as 
customary, in anticipation of fall shipments of cotton and grain, and 
which normally amounted to approximately $400,000,000. On July 30 
the Bank of England raised its discount rate from 3 per cent to 4 per 
cent, a day later to 8 per cent, and on August 1 to 10 per cent, although 
reducing it to 6 per cent on August 6, and to 5 per cent on August 8, 
at which point it remained until July 13, 1916.1. The Bank of France 
likewise raised its discount rate on July 30 from 3% per cent to 4% 
per cent and on August 1 to 6 per cent, although later reducing it 
to 5 per cent. The same policy was pursued by the other central 
banks of Europe. The excessive derangement of the exchanges was 
caused primarily by the moratoria, which had been made effective 
in all the leading European countries. American banks and firms had 
several hundred million dollars of credit abroad, which for the time 
being had to lie dormant and could not be used to offset American 
debts to European creditors. Our exports had been temporarily cut 
off, but even had they not, we would not have been able to compel 
the Europeans to pay us for them owing to the existing moratia. The 
discount houses of London were especially hard hit by the develop- 
ments in the financial markets and finally weathered the storm 
only because of the relief extended by the government and the Bank 
of England.” 

While the closing of the American stock exchanges made impossible 
the further dumping of foreign held stocks and bonds and thus pre- 
vented the piling up of a much greater indebtedness on our part to 
European creditors, at the same time, however, certain difficulties 
followed in its wake. There was no place where we ourselves could 
traffic in stocks and bonds, no price lists of securities were being pub- 
lished, with the result that banks and other financial institutions carry- 
ing investments in securities of various kinds were unable to dispose 
of them and thus obtain the funds so necessary for other purposes. 

Gold continued to leave the United States in large quantities. Dur- 
ing the first two weeks of August, $43,414,000 was sent to Great Brit- 
ain and to France. The insurance rates on gold shipments became 
practically prohibitive, rising to as high as $5.00 per £100 sterling. 


1Cf. p. 406. 
2 Cf. Withers, “‘War and Lombard Street,” p. 59 et seq. 


530 DOMESTIC AND FOREIGN EXCHANGE 


Shipments were risky and expensive, yet the Europeans, especially 
the English, insisted that we pay our debts, although at the same time 
they would not permit us, because of the existing moratoria, to make 
use of the credits which we had to our account in foreign countries. 
American bankers disliked to part with their gold holdings because 
they realized the difficulty of ever getting them back if in the future 
rates of exchange should fall below the gold import point. It was 
also felt that, as soon as the European moratoria expired, exchange 
rates would return to their normal levels. Europe, however, de- 
manded gold, so gold had to be sent even though it meant seriously 
crippling our credit structure. We were owing England, France, and 
other European nations about $500,000,000, maturing between 
August I, 1914, and January 1, 1915. Approximately $200,000,000 
was due immediately. New York City alone owed $82,000,000 on 
tax warrants which had been sold in England and France, payment 
of which had been guaranteed in gold. Ordinarily we would have 
offset our foreign obligations by means of autumn exports of grain 
and cotton, but our exports were temporarily cut off. We could not 
part with all our gold, yet it was cheaper to send gold than to pur- 
chase exchange at the ruling exorbitant rates of exchange. But we also 
had to safeguard the future of our banking and commercial interests. 
The matter of first importance, therefore, was the conservation of 
our gold supply, for gold is the very basis of our credit structure. In 
doing so we had immediate recourse to the issuance of clearing house 
loan certificates and Aldrich-Vreeland emergency bank notes. These 
two forms of currency, it was thought, would at least partly relieve 
the pressure upon our domestic money supply. The Aldrich-Vreeland 
notes, which national banks, by the law of 1907, had been authorized 
to issue under emergency conditions, were difficult and expensive to 
put into circulation. The necessities of the situation being brought 
to the attention of Congress, it immediately (August 4) amended the 
law as requested by the bankers, and bank notes to the extent of 
$384,485,000 were subsequently issued under its provisions. Clearing 
house loan certificates to an aggregate amount of $211,778,000 were 
also issued by banks in twelve of our more important clearing houses, 
but were used solely in clearing house operations and did not get 
into circulation among the public. 

To meet the extremely critical situation, various proposals were 
suggested. It was urged that we, too, declare a moratorium, which 


THE WORLD WAR AND THE EXCHANGES 531 


would relieve us from paying our foreign obligations, but the suggestion 
luckily did not meet with approval. It was also proposed that Eng- 
land establish credits in the United States which could be offset by 
credits which were standing in our favor in England. But nothing 
came of that suggestion. Finally, on August 12, England agreed, 
for the convenience of American debtors, to accept deposits of gold 
with the Finance Department of Canada at Ottawa as the equivalent 
of gold deposited with the Bank of England, thus doing away with 
the risk and expense of shipping gold to England, as well as at the 
same time making us feel that in the future our exported gold might 
possibly be sent back to us if conditions justified its return. The pro- 
posal was accepted, and we began immediately to make gold ship- 
ments to Ottawa. 

A syndicate of New York bankers was organized to take care of the 
outstanding tax warrants of New York City, the syndicate agreeing 
to purchase $100,000,000 of the short time bonds of New York City 
and to undertake the payment of its foreign indebtedness. In the 
course of the syndicate’s operations, it sent $35,264,636 in gold to 
Ottawa and later forwarded $80,243,941 in exchange to foreign coun- 
tries to cover the remainder of the payments that had to be made 
before January 1, 1915. It was also thought advisable to, devise some 
sort of arrangement whereby the other outstanding obligations of 
American banks and firms could be taken care of. On September 4, 
1914, the Federal Reserve Board and the Secretary of the Treasury 
called a conference of representatives of clearing houses in all reserve 
cities for the purpose of estimating our total indebtedness to Europe 
and of devising some means of handling the situation. It was calcu- 
lated that we owed approximately $500,000,000 to European countries, 
maturing during the next few months. The conference recommended 
that a National Gold Fund of $100,000,000 be established for the 
purpose of meeting our obligations, and that the Federal Reserve 
Board circulate a request for subscriptions to this Gold Fund among 
the banks of all clearing houses in the United States. The response 
was prompt and $108,000,000 was immediately subscribed. The profit 
from the operation of the fund was to be derived from the sale of ex- 
change against the sum provided, and was to be distributed on a pro 
rata basis among the contributing banks. This National Gold Fund 
operated secretly and cautiously and made but one call and that for 
only 25 per cent of the subscribed amount. 


532 DOMESTIC AND FOREIGN EXCHANGE 


The above arrangements had the effect of causing a sharp break 
in exchange rates during September. On September 1, bankers’ 
sight drafts sold at 5.0625, but they closed on the 3oth at 4.98%. In 
October, we began retiring our clearing house loan certificates and 
emergency bank notes. The situation had seemed so critical that Sir 
George Paish and Basil B. Blackett had been sent from London for 
the purpose of arranging some sort of loan from England or the Bank 
of England to the United States or to American bankers, in order to 
make further shipments of gold unnecessary. But while our Treasury 
officials and leading bankers were in conference with these emissaries, 
the exchange market collapsed and rates fell below the gold export 
point, thus, temporarily at least, relieving us from the fear of a con- 
tinuing gold drain. Our merchandise exports, which had been cut 
off, also began to increase rapidly, large amounts of breadstuffs and 
cotton being shipped, especially to England. The expiring moratoria 
on bills of exchange in European countries also assisted in bringing 
exchange rates back to normal. The moratorium on some bills of ex- 
change in England terminated on October 19, and by December 3 all 
English moratoria were abandoned. During October exchange on 
Germany ruled at very low rates, because of the exports that we were 
sending indirectly to her and also because of the activities of German 
interests in transferring their accounts to New York, which appeared 
likely to remain a neutral market. Exchange in large amounts was 
being sold on Germany so as to secure funds in New York and thus 
build up German accounts in American banks. Under the system of 
quoting the mark that prevailed at that time, par was approximately 
95.2 ($0.952 per four marks), with the import gold point at 94 7/8, 
yet cables on Germany dropped to as low as 89, while demand ex- 
change closed in October at 88.75. During November the situation 
became even more favorable to the United States, all clearing house 
loan certificates having been redeemed, or a date set for their redemp- 
tion, while the greater portion of the emergency bank notes had been 
withdrawn from circulation. Sterling exchange broke sharply. On 
November 9g, bankers’ sterling sight drafts stood at 4.90 7/8; on the 
toth at 4.89 5/8; on the r1th at 4.89, and on the 12th at 4.86 3/4. The 
outstanding cause for the spectacular decline of November 12 was the 
announcement that the New York City loan syndicate had been able 
to purchase all the required exchange at a rate considerably below 
4.90. Speculators who had been buying up exchange, hoping to sell 


THE WORLD WAR AND THE EXCHANGES 533 


to the syndicate at higher rates, found that they had been outwitted, 
and threw their supply upon the market, causing the rate to decline 
unexpectedly. The rate, however, strengthened slightly during the 
latter part of the month, due to the announcement that the Stock Ex- 
change of New York was to open on November 28, although only 
for bond trading. There was some fear that there might be consider- 
able selling for foreign account, even though the latter was forbidden 
by the stock exchange authorities. Sterling closed on November 30 
at 4.89. On December 12 the Stock Exchange was opened to limited 
trading in stocks, but issues of an international character were at first 
kept off the list. Three days later, however, came the announcement 
that the Stock Exchange was open to trading in all securities. On the 
22nd, as indicative of the satisfactory condition that prevailed, the 
New York Clearing House notified its members that thereafter bal- 
ances had to be paid in gold certificates or in other lawful money. 
The London Stock Exchange opened on January 4, 1915. As the 
year closed, new moratoria were declared by France, Italy, Sweden, 
Hungary, and other continental countries. Exchange in New York 
continued to seek lower levels, sight drafts on England closing on 
December 31 at 4.8525. The hindrances to our foreign trade had been 
gradually removed, and exports began to increase rapidly. Mer- 
chandise imports, however, were curtailed somewhat for the reason 
that trade with Germany was practically impossible. Our monthly 
favorable balance of trade during the winter and fall months of 1914 
was as follows: 


RUteTINGI NG Mert ica egies otc Ne $16,341,000 
NO eT ue anna Os aig 2 yates 56,630,000 
OVC CTME Rye erin sole. io. s utes 79,411,000 
LL PEGOIT CTEM Ia t, cent h etn Sk ow aye.ué bys <8 131,863,000 


This increasing balance of trade meant a large supply of exchange 
and therefore lower rates. Demand for exchange eased up con- 
siderably, partly because there were few American tourists abroad 
and because of the fact that a smaller amount of remittances was being 
made to relatives in foreign countries; also our obligations abroad had 
been fairly well taken care of by the means above described. 

During the first week of January, 1915, the Treasury Department 
of the United States and the Treasury Department of Great Britain 


534 DOMESTIC AND FOREIGN EXCHANGE 


reported that exchange conditions were back to normal and that there 
was no longer any necessity of carrying on the negotiations which had 
been begun during the fall of 1914 looking toward an adjustment of 
exchange relations between the United States and England. During 
January the exchanges continued to weaken without forcing the Bank 
of England to part with any of its gold, sight exchange selling as low 
as 4.8325. One special cause for this pronounced weakness was the 
fact that the Canadian Government had secured a loan in London 
for the purpose of purchasing war supplies in the United States. To 
make those funds available, Canada sold sterling bills in New York 
and oversupplied the market. In the latter part of January, a sharp 
rise in exchange rates occurred in spite of a rather liberal offering of 
grain and merchandise bills, occasioned by the demand on the part of 
American bankers for exchange with which to meet maturing finance 
bils as well as to make payments for foreign held American securities 
which had been sold in the United States. On the rise, sterling ex- 
change reached 4.85 3/8, but closed at the end of the month at 4.84%. 
Gold now commenced to flow into the United States from various 
countries, and during the second week of January We received ap- 
proximately $4,000,000 in gold. Our favorable balance of trade for 
the month totaled $145,536,000, the largest that we had had up to that 
time. The effect of this exceptional trade balance was a further drop 
in the exchanges, not alone on London, but also on all continental 
centers. By February 16, sterling sight drafts had fallen to 4.79, the 
lowest rate since the crisis of 1857. ‘There was considerable selling of 
American securities for foreign account during that month, bond sales 
alone aggregating more than $2,000,000. The Bank of England still 
resisted the pressure to send us gold, although during February it did 
forward $8,250,000 from Ottawa to be deposited in a New York bank 
for the account of the French government and the Bank of France. 
France was purchasing war supplies from us and the gold was to be 
used to pay for them. Some gold also arrived from London, Japan, 
and certain of the South American countries. During March the 
National Gold Fund concluded its activities, announcing that since 
its organization it had sent only $10,000,000 in gold to Ottawa at an 
expense of $16,542, $11,000 of which had been expended for the trans- 
portation of gold. The Fund had operated without the payment of 
fees or salaries and had successfully served the purpose for which it 
had been created. 


THE WORLD WAR AND THE EXCHANGES 535 


During the latter part of 1914 and the early part of 1915, merchants 
and bankers from practically all countries of the world established 
credits in the United States for trade purposes, which led to the ques- 
tion being raised as to whether or not England was paying dearly for 
her moratoria. For the time being it looked as though the financial 
center of the world was to be shifted from London to New York, for 
New York had remained the only free gold market in the world, placing 
no hindrances whatsoever on the flow of gold or on the use of credits 
deposited in that city. It seemed probable that New York would be 
called upon more and more, as time passed, to assist in financing the 
needs not only of the belligerents but also of the neutral countries. 
Early in 1915 the Canadian provinces had begun to borrow heavily 
from New York, their needs having previously been met by London, 
and this borrowing has continued to a great extent down to the present 
time. As months passed, other loans were floated on behalf of Eu- 
ropean and South American countries. 

From January to April, 1915, we had imported approximately 
$43,000,000 in gold. These imports, together with the large amount 
of American securities which had been returned to us by foreign 
holders, and the interest and dividend payments and other incidental 
charges and remittances which we had made—all creating a demand 
for exchange—were not enough to maintain rates at their normal 
levels. Sterling dropped lower and lower, declining to 4.78 15/16 on 
April 22. Even at that low rate, the shipment of gold from England 
was hardly profitable because of the heavy costs of insurance and 
freight, coupled with the danger of loss by submarine attack. Sterling 
rates would undoubtedly have fallen to lower levels had not the New 
York dealers felt that an effort would soon be made to arrange credits 
in New York on behalf of the warring nations. Our favorable balance 
of trade continued to increase by leaps and bounds. Our huge excess 
of exports clearly indicated that exchange was destined to reach lower 
levels unless some effort was made to prevent a further decline. In 
June, 1915, sterling dropped to 4.7625, a new low record. Gold was 
flowing in to us at a rapid rate. Over $120,000,000 had arrived in the 
first six months of 1915, of which $90,000,000 had come from the Bank 
of England’s holdings in Ottawa. On July 30, sterling reached 4.7575; 
on August 31, 4.555; and on September 1, 4.50. 

At that rate it would have paid American bankers to buy gold in 
England for import. England now began to fear the loss of her gold 


530 DOMESTIC AND FOREIGN EXCHANGE 


holdings and the crippling of her war finances. She was about to be 
forced to take steps to protect her exchange. The other European 
exchanges were also at a decided discount. 

The declining rates of exchange created a most difficult situation 
for American exporters and for foreign importers. Exporters were un- 
able to determine approximately what their drafts would be worth 
when goods were ready for shipment, and under the circumstances were 
forced to charge excessively high prices. With exchange on England, 
say, at 4.76, exporters who had been accustomed to receive at least 
4.86 for a sterling draft were compelled to add t1o¢ to their prices for 
every pound sterling’s worth of goods sold in order to make up the 
loss which they would suffer because of the depreciated exchange. 
For the same reason the Allies, who were purchasing increasingly large 
quantities of war supplies, were forced to pay proportionately higher 
prices. England, who was in reality financing the war for the Allies, 
soon appreciated the necessity of obtaining a loan from the United 
States, and in September, 1915, sent a commission to us for that pur- 
pose. The commission asked for one billion dollars, but at that time, 
because we were new to the task of making international loans, we 
were willing to grant but $500,000,000. This loan was to bear interest 
at 5 per cent, and was to be a dollar loan, the proceeds to be deposited 
entirely in American banks and used only for the purpose of buying 
supplies in our country. When the commission left London for the 
United States, sterling was at 4.50. By the time its members reached 
New York, sterling had climbed to 4.725, but, after the terms of the 
loan had been arranged and the commission had departed for London, 
sterling fell to 4.605. During the remainder of the year, however, 
sterling gradually rose until in January, 1916, it reached 4.765, which, 
on the basis of the excessive insurance and shipping costs, represented 
in reality a new import point for gold. England thereupon decided 
to peg sterling at that level, and her efforts were so successful that, 
until she unpegged her exchange on March 18, rg19, she was able to 
keep sterling fluctuating around 4.75. 

England’s pegging arrangement consisted of four parts: first, the 
mobilization of English-held American securities and the use of the 
funds received from their sale in the United States in the purchase 
of sterling cables, thus artificially creating a demand for English 
exchange and stiffening the rate; second, the securing of loans and 
the establishing of credits in the United States, thus reducing the 


THE WORLD WAR AND THE EXCHANGES 537 


supply of sterling exchange; third, gold shipments; and fourth, 
regulations looking toward the restriction of unnecessary imports. 

In July, 1915, England had organized the Committee on American 
Dollar Securities, but nothing was done toward the mobilization of 
such securities until the close of that year. England then appealed to 
her citizens, and especially to the insurance and trust companies, 
either to sell or to loan their holdings of American securities to the 
government. In case of sale, payment was to be made in five-year 
5 per cent Exchequer bonds, the price of the securities being fixed at 
the New York quotation converted at the prevailing exchange rate 
on the date of sale. This arrangement permitted the holders to profit 
by the depreciation in the sterling rate in the United States. If the 
securities were loaned to the government, the owner was to receive 
the regular interest and dividend payments thereon, plus an additional 
return of one-half of one per cent per year from the government. At 
first the loan was to be for only two years, but it was subsequently 
extended to an indefinite length of time. The owner was also given 
the privilege of requesting the Treasury at any time to dispose of the 
securities in New York and to pay him the proceeds converted into 
sterling at the prevailing rate. Canadian and South American issues 
were also mobilized, but were employed chiefly as collateral for loans 
which we later advanced to England. 

England experienced great difficulty in securing a sufficiently large 
supply of securities for her purpose. Holders were reluctant to part 
with their high yield American stocks and bonds. ‘The government 
was finally compelled to resort to force, and on May 29, 1916, passed 
a law imposing a special tax of 2s. per pound of income received from 
all issues asked for by the government. The Income Tax Act of 1916 
also included a one per cent tax on United States securities held by 
non-resident aliens. After January 1, 1917, this was further increased 
to 2 percent. But even so, a sufficient amount of the desired securities 
was not forthcoming, and under the provisions of the Defense of the 
Realm Regulations, the Treasury was given power to compel the 
holders of certain issues to turn them over to the government. This 
final regulation was most effective, and the government experienced 
no further difficulty in obtaining the needed securities. 

The method of employing the mobilized stocks and bonds was very 
simple. As sterling weakened in New York, the American agent of 
the English government (J. P. Morgan & Company) went into the 


538 DOMESTIC AND FOREIGN EXCHANGE 


market, sold a sufficiently large amount of the securities, and then 
with the proceeds purchased cables on London until the rate was 
forced back to its pegged position, which represented about a two per 
cent discount on the par of exchange. The rate determined upon was 
4.76 7/16 for cables, which meant that sight sterling was expected to 
fluctuate between 4.75 and 4.76. This rate was a trifle lower than the 
point at which it would pay to import gold, but the risks of capture 
or loss by submarine were so great that England knew that American 
bankers would not be active as importers of the yellow metal. 

The acquisition of securities was discontinued on April 29, 1919. 
During the existence of the Dollars Securities Committee, it acquired 
approximately $1,400,000,000 of American and Canadian securities, 
not to mention additional amounts of sterling, franc, krone, and other 
denominations. Of the securities loaned to the Committee, £307,- 
605,065 were of sterling denomination, $648,314,720 were Canadian 
and American securities, and £21,096,800 were in other currencies. 
The cost to the government of the additional one-half per cent allow- 
ance on the loan of these securities was £1,800,000 in 1919-1920; 
and less than £1,500,000 in 1920-1921. All the transactions of the 
Committee were concluded by March 31, 1922.1 The total cost per 
year to the English government of operating its security mobilization 
scheme was estimated at about $1,250,000,000. The arrangement 
was successful and in itself expensive, but had England not spent that 
sum of money annually in pegging its exchange rate, it would have had 
to pay an even greater sum because of the much higher prices that 
would have been charged for the war supplies of the Allies on account 
of their more greatly depreciated exchanges. 

After our first loan to England and France in 1915, it was only a 
short time until the Allies were in the American market for additional . 
advances. All the loans subsequently made were dollar loans, the 
proceeds being deposited in American banks and drawn on by Ameri- 
can exporters. The extent of the loans privately floated, as well as 
the amount of credits advanced by the United States government 
after we entered the war, have been fully commented upon elsewhere.” 
Their effect was, in brief, the curtailment of exchange of all kinds on 
the Allied nations. Sterling, franc, and lire drafts were no longer 


1Statement of the Chancellor of the Exchequer, Commercial and Financial Chronicle, 
April 9, 1921. 
? Cf. pp. 332-330. 


THE WORLD WAR AND THE EXCHANGES 539 


drawn as before; in their stead American exporters drew drafts in 
dollars on the accounts of the Allies which had been deposited in New 
York banks. This extensive reduction in the supply of exchange 
helped materially to stabilize the exchange rates. 

Immediately upon the outbreak of the war, England, France, and 
Russia pooled their gold resources in order that their funds might 
be made more effective. The control of the gold was placed with Eng- 
land, who was to use it in such a way as to keep the exchange rate peg- 
ged and the American money market in an “easy” condition. Some of 
this gold came across the Atlantic convoyed by warships; some across 
the Pacific. The greater part was sent direct to Ottawa. From time 
to time, as the exchange market stiffened, or as money rates in New 
York gave evidences of rising, this gold was sent to the United States, 
its arrival being nicely timed to have the desired effect. By this means, 
the Allies were able to keep the exchange rate at the desired position 
and the money rates lower than they would otherwise have been.! 

England and the other allied countries also succeeded in placing an 
effective embargo upon unnecessary imports and so reduced the 
amount of exchange that would otherwise have been drawn in con- 
nection therewith. Not only were luxuries placed under the ban, but 
an effort was also made to allow only the required amount of the 
necessities to be imported. 

France and Italy also mobilized their American securities and co- 
operated with England in the stabilization of the exchanges. Ger- 
many was cut off from the American markets, but sold her American 
securities to Dutch and Scandinavian investors, who in their turn 
sold them in the United States until prevented from so doing by the 
confiscation policy adopted by the Allied countries. It was this sale 
of securities by the Dutch and the Scandinavians, either for them- 
selves or for German account, that caused the New York exchange 
rates on Holland, Sweden, Denmark, and Norway to remain above 
par in spite of the adverse balance of trade of those countries with 
the United States. 

After 1915 our favorable balance of trade continued to expand at 


1A total of $1,200,000,000 gold was handled for England by the Department of Finance 
of Canada. Of that amount, $546,000,000 was for the account of the Bank of England 
and the remainder for the account of the British government. In 1914, $104,000,000 was 
received from the United States. This was subsequently returned to us when the rates 
of exchange shifted. Of the total amount passing through Ottawa, $491,000,000 came 
from Great Britain, $353,000,000 from South Africa, $253,000,000 from Russia, $692,000 
from Borneo, and $172,000 from Brazil. 


’ 


540 DOMESTIC AND FOREIGN EXCHANGE 


an astonishing rate, amounting to $3,091,005,766 in 1916, $3,281,044,- 
642 in 1917 and $3,118,087,926 in 1918, while during the same years 
securities and gold flowed in to us in unsurpassed amounts. Rates of 
exchange on England fluctuated but slightly during those three years, 
remaining constantly at a little less than a two per cent discount. 
Francs and lire, although tied to sterling, moved at lower levels. 
Francs during 1916 were down to about a 12 per cent discount, and in 
‘ EXCHANGE RATES IN NEW YORK ON BELL/GERENT COUNTRIES 
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CuHarT XIII 


Highest monthly sight rates in New York on belligeren_ 
countries, June, 1914—July, 1918. Percentage 
fluctuations from par. Adapted from Federal Reserve 
Bulletin, September, 1918, p. 841. 


1917 and 1918 they ranged at about a ro per cent discount. Lire 
followed more closely Italy’s fortune in war. During 1916 they were 
down to about a 20 per cent discount, while in 1917 and 1918 they 
dropped to a discount of about 30 to 35 per cent. Rather early in the 
conflict rubles began to depreciate, reaching a discount of 35 per 
cent in 1915, 41 per cent in 1916, 74 per cent in 1917, and finally dis- 
appearing altogether from the market in 1918. Although Germany 
made no effort to stabilize the mark, it held up much better than the 
ruble, falling to a discount of 17 per cent in 1915, 27 per cent in 1916, 


1Qur excess of gold imports for 1916, 1917, and 1918 was respectively $529,952,000 
$181,542,000 and $21,102,000. 


THE WORLD WAR AND THE EXCHANGES 541 


and 25 per cent at the time we entered the war in 1917. The rates 
on the European neutrals remained consistently above par until the 
close of the war, and as a consequence gave our importers consider- 


EXCHANGE RATES MY NEW YORK ON NEUTRAL COUNTRIES. 


RAARTADERMRREEORREE 


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SN PP Ae aA Sea Meee MARE SMT Oo ae 
Eh eS a A TL EY A AE a a SA a a A A DF 
2.) DY RT A A A LL ee _—- 


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ae i 





CHART XIV 


Highest monthly sight rates in New York on neutral countries, June, 1914- 
July, 1918. Percentage fluctuations from par. Adapted from Federal 
Reserve Bulletin, September, 1918, p. 843. 


able difficulty, especially those who were purchasing supplies in Spain. 
The peseta reached a 10 per cent premium in 1916, but in 1917 went 
to a 26 per cent premium, and in May and June, 1918, to a 42 per cent 
premium. The premium on the peseta and the necessity of shipping 
gold to Spain proved to be a problem difficult for the American im- 
porters to understand, especially in view of the fact that we were ex- 
porting a far larger amount of goods to Spain than we were importing 
from her. The reason for the premium on Spanish exchange was 
simply this: England was buying heavily from Spain. Spanish mer- 
chants had drafts on England which they wished to dispose of at the 


542 DOMESTIC AND FOREIGN EXCHANGE 


highest possible rate. England had not stabilized sterling in any 
country except the United States, as a consequence of which sterling 
had fallen to a much greater discount in all other centers. Sterling 
drafts could be sold in New York for about 4.75, so the Spanish mer- 
chants disposed of their London exchange in the highest market, 
which was New York. These sales created Spanish credits in New 
York and caused such a heavy demand for Spanish exchange that it 
more than offset our favorable balance of trade with Spain and hence 
caused the rate for pesetas to rise greatly above the gold export point. 
American importers complained that England’s pegging scheme caused 
us to bear an unjustified burden and also to lose a portion of our gold 
holdings.? 

With the other European neutrals, however, the situation was not 
quite so serious. In the early part of 1917, after we had entered the 
war, the United States began to assist England in keeping supplies 
from Germany by placing an embargo on exports to the neutral coun- 
tries. This action curtailed the supply of exchange on those countries 
and raised the rates above par. This state of affairs continued until 
the early months of 1919. 

Exchange on Canada ruled at a discount during the period of the 
war, except for the months of August to November, 1914. Canada’s 
purchases from us were so large, and the loans which we floated for 
her were so great, that no other result than a depreciated exchange 
(averaging about a 2 per cent discount) could be expected. 

The United States did not interfere with exchange operations or 
with exchange rates until after we had been at war with Germany 
for several months. On September 7, 1917, the President issued a 
proclamation placing the export of coin, bullion, and currency under 
the authority of the Federal Reserve Board. Shipments to the neutral 
countries were absolutely prohibited by the rulings of the Board, 
because of the fear that they would undoubtedly reach Germany 
sooner or later. Some shipments were made to South America and 
Oriental countries, and later to other points.” By subsequent proc- 
lamations, complete control of the exchanges was placed in the hands 
of the Federal Reserve Board. This intensive (and really cumber- 

1It was estimated that during 1917 and 1918, with the peseta considerably above par, 
the marketing of Spanish owned sterling drafts in New York cost the importers of the United 
States approximately $4,009,000 a year. 


2 The restriction on gold exports caused gold to rise temporarily to a premium of 35 
per cent in China and 85 per cent in India. 


THE WORLD WAR AND THE EXCHANGES 543 


some) regulation of the exchange market lasted until June 26, 1919. 
Restrictions on exchange transactions with Russia were retained, 
however, until December 20, 1920. During the period of control 
licenses were approved for the export of gold, silver, and currency 
aggregating $863,253,670.! 

On November 11, 1918, the World War was brought to a close by 
the declaration of an Armistice. England, uncertain of the immediate 
future, continued to peg her exchange as before. By March 18, 1919, 
however, all danger seemingly being past, she withdrew her official 
support from the exchanges, and the market collapsed.? Her pegging 
arrangement was costing approximately $1,250,000,000 a year, and 
with the war over she could not afford to continue such a heavy ex- 
penditure. Rates of exchange were allowed to seek their “normal” 
or “natural” levels. In a day’s'time, sterling dropped to 4.70, francs 
to 5.75, and lire to 6.38 (the old method of quoting francs and lire was 
still in use at that time). The course of all exchange for some time 
thereafter was downward at an astonishing rate, the low quotations 
for the year being as follows: sterling on December 12, 3.6525; francs 
on December to, 11.84; lire on December 11, 13.60. We had begun 
quoting marks during 1919, and they too declined to a low record of 
0.0187 on December 9. Canadian exchange fell to a discount of 4 per 
centin November. The neutral exchanges also weakened considerably. 

During 1920, the exchanges in New York reached their lowest levels. 
On February 4, owing to the rumor that England was about to declare 
an embargo on cotton imports, sterling dropped to 3.18, but recovered 
rapidly, although easing off again as the year passed, and closing in 
December at 3.52. “The arbitrage of exchange through London was 
so free and constant throughout the year 1920 that, except for special 
conditions which applied to certain local currencies, sterling exchange 
was closely followed by all the other exchanges.” ? Francs reached 
their low record on November 11, at 0.05705 per franc (new method of 
quoting, or 17.528 by old method), closing at 0.05865 on December 31. 
Lire sank to 0.0331 (new method of quoting, or 30.211 by old method) 
on December 28. Canadian exchange declined to a 15 per cent dis- 


1Cf. Annual Report of the Federal Reserve Board, 1918, pp. 39-46, for a statement of 
the regulations imposed on exchange transactions during the war. 

2 From February, 1916, to March 18, 1919, sight sterling had not fallen below 4.75 1/8, 
so successfully had it been pegged. 

3 Annual Report of the Federal Reserve Board, 1920, p. 29. 


544 DOMESTIC AND FOREIGN EXCHANGE 


count in February, but recovered slightly as the months passed, and 
then closed at a discount of about 14 per cent. 

During 1921 the exchange market stiffened slightly from January 
to May, then eased off somewhat until early fall and closed in Decem- 
ber at a higher level than had prevailed at the opening of the year. 
Marks ruled at increasingly lower levels. The yen fell below par and 


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CHART XV 


Exchange rates in New York on England, France, Germany, Italy, Nether- 
lands, Argentina, and Japan, November, 1918-December, 1921. Per- 
centage fluctuations from par. Adapted ‘from Federal Reserve Bulletin, 
January, 1922, p. II5. 


so remained during the entire twelve months. The Swiss franc ad- 
vanced from a low of 15.22 in January to above par on December 14, 
and was the first of the European currencies to be quoted in New 
York at a premium after the general depreciation of the exchanges. 
The rates on other neutral countries likewise rose, but did not attain 
par during the year. 

The spring of 1922 has seen a continued rise in the more important 
European rates, the closing quotations on March 31 being as follows: 
sterling 4.3725; francs 9.0025; lire 5.10; marks 0.0033; pesetas 15.45; 
and Swiss francs 19.40. On the same day the Canadian dollar stood 
at a discount of 2 13/16 per cent. 


THE WORLD WAR AND THE EXCHANGES 545 


The rather phenomenal rise in certain of the European rates was 
due primarily to the success attendant upon efforts to put financial 
conditions on a better basis. England has been most active in that 
connection. The existence of a discount on sterling militated against 
its return as the international monetary unit in foreign trade connec- 
tions. No country that has any regard for its financial standing among 
the nations of the world cares to see its currency at a discount. Eng- 
land furthermore has realized that with the possibility of having to 
pay off some of her foreign loans and also the interest on other loans 
in the near future (interest payments to the United States were to be 
postponed only until the spring of 1922), it would be rather expensive 
to have to make such payments in a depreciated currency. In fact, 
when she paid us her share of the Anglo-French Loan of 1015, it cost 
her £59,229,000 instead of £50,830,000 which were the proceeds of her 
share of that loan.' She has therefore been striving to bring sterling 
back nearer to par. Just how soon she will accomplish her object is, of 
course, uncertain. She hesitated to make any efforts in that direction 
immediately after the war because she felt, as Lloyd George so well 
put it in August, ro1g, that “The adverse American exchange rate in 
itself is protection against the importation of manufactured goods, 
something which England is anxious to bring about in order to save 
herself from her present plight brought about by the war.’ ? There 
has been a notable decrease in her imports from the United States 
and certain other countries which has given her a better opportunity 
to get her own industrial and commercial machinery on a more satis- 
factory basis in preparation for the extension of her activities in the 
world’s markets. Other nations of Europe have likewise profited, at 
our expense, by permitting their exchanges to remain at a discount. 
We can buy—but we are hindered in selling because, with the dollar 
at a premium, our goods are too expensive for foreigners to buy. 

Beginning with the debacle in the exchange market following March, 
1919, there has been a constant agitation in all parts of the world, 
either for the stabilization of the exchanges or for their improvement. 
World trade has been seriously handicapped because of the many 
uncertainties of a financial character that have existed. In the dis- 
cussion as to what ought to be done many have confused the meaning 
of the terms “stabilization” and “improvement.” Stabilization 


1Commercial and Financial Chronicle, November 13, 1920. 
2 Journal of Commerce and Commercial Bulletin, August 25, 1919. 


546 DOMESTIC AND FOREIGN EXCHANGE 


refers to the act of fixing the exchange rate at some point, of course 
at a discount, and keeping it there, as England did with sterling during 
the war, or as Argentina has done with her paper peso. Improvement 
or appreciation means bringing the exchange rate of a country back 
to par or normal.! 

It has been suggested that those countries whose currencies are at a 
discount of more than 20 per cent should make no attempt to restore 
their currencies to the 1914 level. To bring the exchanges of those 
countries back to normal within a short period of time would require 
extensive deflation, with serious results to all financial and business 
interests in the countries concerned. It took the United States about 
fourteen years to return its greenbacks to par, and there is no reason 
for presuming that countries like Germany, Austria, Poland, Russia, 
etc., can accomplish parity or should even attempt to accomplish it 
within the space of a few years. Stabilization of the currencies of 
these countries at a fixed discount is now being strongly recommended. 
Lloyd George is quoted as having declared before the Genoa Confer- 
ence (April, 1922): 


“Before trade can be fully restored you must have established every- 
where convertibility of currency into gold or its equivalent—convertibility 
of liquid assets lodged in banks of a country maintaining a free gold market. 
This will involve the revaluation of currency. The world cannot afford to 
wait until currency is restored to par. What matters is stabilization at a 
figure that can be maintained and which will, therefore, contribute a re- 
liable basis of international commerce.” 


At the close of the Revolutionary War, to cite again from our ex- 
perience with depreciated paper money, we found ourselves swamped 
with a mass of inconvertible paper money with no possibility of ever 
being able to redeem it at par. We boldly—and from some angles 
probably unwisely—announced on August 4, 1790, that we would 
fund our paper issues in 6 per cent bonds “at the rate of one hundred 
dollars in the said bills for one dollar in specie.”” This was an outright 
repudiation of millions of dollars of our obligations, but it enabled 
our government to get on its feet financially much sooner than would 
otherwise have been possible. Some writers have urged that Germany, 


1QOne of the most excellent discussions on this matter, entitled “‘The European Ex- 
changes,” by Professor J. M. Keynes, appeared in the Manchester (England) Guardian, 
April 7, 1922. 


THE WORLD WAR AND THE EXCHANGES 547 


Austria, Russia, Poland, and other countries similarly affected by 
worthless currency should follow our earlier example in order to hasten, 
although by a bitter route, the progress of reconstruction. A still 
better plan might be the adoption at present of a rate of discount or 
redemption which would be decreased as the financial condition of 
the country improved in the future. Some writers have suggested 
that all of the old currency be abandoned and that a new unit be 
adopted as the standard of value, in terms of which the old currencies 
would be redeemed at a fixed rate of discount. This again would in- 
volve partial repudiation, which always seriously affects a country’s 
credit standing among the nations of the world. 

For nations like England, France, Italy, Belgium, Holland, Switzer- 
land, Czecho-Slovakia, and the Scandinavian countries, convertibility 
into gold might be more easily established at the present moment on 
the basis of a sliding discount arrangement or by agreeing now upon 
a fixed future date when convertibility would be effective. The latter 
scheme was the plan adopted by the United States in connection 
with its greenbacks, and with satisfactory results.1 Professor J. M. 
Keynes has proposed ” that a sliding scale of appreciation be adopted 
by this group of countries, which should never advance by more than 
one-half of one per cent per month. Thus, if a nation’s currency, 
as gauged by its exchange, were at a discount of ro per cent, that 
country might, if financially able to do so, bring its currency back to 
par within the short period of 20 months. To aid in a more rapid re- 
covery, he also suggests that gold be loaned to the central banks of 
Europe by the Federal Reserve banks of the United States at an 
interest rate of 10 per cent per year in order to enable the central banks 
to bring their gold reserves up to at least 15 per cent of the outstanding 
paper circulation. Not more than $150,000,000 should be loaned to 
any one institution and not more than $50,000,000 at any one time. 

Various other proposals have been made looking more especially 
toward the rectification or appreciation of the exchanges rather than 
to their stabilization. 

Senator Hitchcock of Nebraska has urged the United States to es- 
tablish a ‘Bank of Nations” with a capital of $2,400,000,000, one- 
sixth of which would be contributed from the gold holdings of the 


1In January, 1875, Congress passed a law authorizing the resumption of specie payments 
on January 1, 1879. 
2 Manchester Guardian, op. cit. 


548 DOMESTIC AND FOREIGN EXCHANGE 


United States Treasury, the remainder to be subscribed by those 
nations which agreed to enter into the arrangement. The bank would 
be controlled solely by the United States, although it would be partly 
owned by foreign countries and could also act as their fiscal agent. 
It would issue what would be known as the “international dollar,” 
which, presumably being freed from fluctuations, would, according 
to the proposed plan, become the international unit of value and thus 
stabilize exchange. Somewhat similar to this scheme is the suggestion 
that we should establish a Federal Reserve Foreign Exchange Bank, 
which would be owned by banks in the United States and which would 
be the central agency through which all foreign trade financing and 
all foreign exchange transactions should take place. Another pro- 
posal is that the central bank of a country should be given a com- 
plete monopoly of the exchange field. Centralization of control, it is 
thought, would bring much better results than are obtainable with 
the present condition of decentralization. 

Some writers have proposed that all the nations of the world should 
adopt a universal or international standard of value, or coin, in terms 
of which all foreign business should be conducted. The advocates 
of this plan seemingly overlook the fact that in times of war, a standard 
of value which has been adopted by two or more countries may fluc- 
tuate just as widely as though the countries concerned were on different 
standards of value, viz., note the fluctuations of the Canadian dollar 
in terms of the American dollar; the fluctuations of the French franc 
in terms of the Belgian franc or the Swiss franc, etc., etc. 

The adoption of “pegged” exchange might again prove effective, 
but it is far too expensive for any nation to countenance as a peace 
measure. It can be justified only as a war necessity. As the Brussels 
International Financial Conference declared: 


“Attempts to limit fluctuations in exchange by imposing artificial con- 
trol on exchange operations are futile and mischievous. In so far as they 
are effective they falsify the market, tend to remove natural correctives 
to such fluctuations and interfere with free dealings in forward exchange 
which are so necessary to enable traders to eliminate from their calcula- 
tions a margin to cover the risks of exchange, which would otherwise con- 
tribute to the rise in prices.” 


Czecho-Slovakia, however, is still attempting a modified form of 
“negging” by acquiring a government reserve consisting of foreign 


THE WORLD WAR AND THE EXCHANGES 549 


exchange bills, which it uses in purchasing Czecho-Slovak exchange 
whenever it declines to too great a discount. The object is not com- 
plete stabilization, but merely the reduction of fluctuations to a mini- 
mum. 

Since the war we have made extensive loans to the European coun- 
tries, their cities and corporations, which, as was to be expected, have 
had some beneficial effect on the exchanges. It has been urged that 
we continue such advances and thus further assist in returning con- 
ditions to normal. We have been happy to loan to those countries 
which are already in a fairly satisfactory financial condition, but we 
naturally hesitate to advance funds to those nations which are deepest 
in the mire of depreciated paper money, and yet which really need our 
assistance more than do those to which we have loaned so freely. 

The cancellation of international debts has also been proposed. 
The United States has been urged to cancel the debts of England 
provided England in its turn cancels to an equal amount the debts 
owing her by the European countries. Cancellation would make 
interest payments and the payment of principal at maturity unneces- 
sary, and would remove from the future markets what may prove 
to be a rather disturbing factor. It would also enable the countries 
which would thus be freed from their obligations to use the funds 
thereby made available to stabilize or improve their currencies. While 
cancellation of international indebtedness is not a probability, never- 
theless steps are being taken at the present time to postpone payment 
until some far distant date. Congress has already authorized the 
funding of foreign loans in some form, of long time bonds, so as to 
relieve foreign countries and our own markets from the disturbing 
effects of payment in accordance with the terms of the loans as origi- 
nally made. 

A resort to barter has not only been advocated but has actually 
and successfully been put into operation in Europe, especially be- 
tween Germany, Holland, and Russia. But international trade can- 
not advance or function properly if confined to a barter basis. We 
are too accustomed to the practices of a credit society ever to be will- 
ing to revert to any extent to a system of barter which business and 
commerce abandoned many centuries ago. 

Some of the European nations (Finland, Belgium, Germany, Poland, 
Italy, Greece) have enacted laws prohibiting speculation in the ex- 
changes or limiting trading therein to bankers and to only those 


550 DOMESTIC AND FOREIGN EXCHANGE 


transactions which are economically necessary. In Holland an 
Exchange Bank, Ltd., with a capital of 5,000,000 florins, has been 
established by a group of eleven banking concerns in collaboration 
with the Amsterdam Liquidation Bank, for the purpose of establishing 
an official terminal market in foreign exchanges, which will lend its 
services in the purchase and conversion of foreign currencies. In 
Belgium a “Caisse Internationale de Liquidation et de Garantie des 
Opérations en Marchandises”’ was organized in 1920 by a group of 
Belgium bankers to rectify the sudden and disturbing fluctuations in 
the various exchanges by means of extensive future transactions, and 
by facilitating “coverings by extending the market and centralizing 
the demand and supply of the whole world. Finally the promoters 
aim at assuring the contracting parties against risk of non-execution 
on the part of one or the other, by guaranteeing the settlement of 
all registered contracts.” 4 

Some of the European countries have officially placed a ban upon 
imports of luxuries; others have raised tariff walls, or have adopted 
other policies for the purpose of decreasing foreign indebtedness, and 
thus relieving the pressure upon their exchanges. In Denmark in 1920, 
while no compulsory legislation had been passed, the bankers agreed 
to assist in restricting unnecessary imports by refusing to advance 
credit for their purchase. 

Other schemes of reform have been advanced, having, as their 
primary object, the development or continuance of foreign trade 
activities through the medium of long time credits. European debtor 
nations require supplies; creditor nations, especially the United States, 
are eager to sell but cannot do so because the debtor countries are 
unable to pay. We might loan them the money to purchase our goods, 
but it would be similar to a customer receiving a loan from a merchant 
with which to purchase the merchant’s goods, especially where the 
customer is acknowledged to be a poor financial risk. On the other 
hand, if the customer is able to put up satisfactory collateral, the 
chances of loss are by so much minimized. This last suggestion is 
the essence of the plan advanced by the Brussels International Finan- 
cial Conference, which has come to be known as the “ter Meulen”’ 
plan. This scheme enables a country needing raw materials and pri- 
mary necessities to pledge its assets as security for an issue of bonds 
with which foreign exporters may be paid. An international commis- 


1 Quoted from a circular issued by the Caisse Internationale. 


THE WORLD WAR AND THE EXCHANGES 551 


sion of bankers and business men is to form the administrative com- 
mission. “The plancontemplates that parties desiring to import goods 
from another country, and particularly where a time credit is desired, 
shall lay before the International Commission whatever security they 
desire to offer and that this security shall be examined by the Com- 
mission and a value in gold fixed upon it. This having been done, the 
government of the importing country will issue its own bonds, in 
terms of the money of the exporting country, and loan them to the 
importer to be offered as collateral for the purchase money obligations. 
This proceeding produces a combination of private and government 
credit, with the entire transaction supervised by the International 
Commission. In case of default, the pledged security is to be in the 
custody of the Commission. The government bonds are differentiated 
from other government issues in that they are backed by specific 
security, supplied by private parties. The loan of government bonds 
is intended to secure the codperation of the importer’s government 
in the collection of the debt, and to supply an additional guaranty. 
It is true, of course, that the ter Meulen plan does not solve the very 
difficult exchange situation, which at this time is the chief obstacle 
to trade. It does not attempt to deal with this except as by making 
provision for the best obtainable class of time credits. It may make 
possible a considerable amount of trade without the necessity for 
immediate settlements,” 1! payment for the goods by the country 
concerned being postponed until a future date, by which time, it is 
hoped, the country will be on its feet financially. The scheme has 
been widely approved by various financial and business organizations 
as well as by the League of Nations, but thus far only one country, 
Austria, has applied for assistance under its terms. From stray re- 
ports here and there, one is led to believe that it has not worked out © 
successfully in that one instance because of the hesitancy of the in- 
vestment market to absorb the ter Meulen bonds that have been 
issued in that connection. 

Practically every nation has adopted some sort of scheme for the 
long time financing of foreign trade. England has been especially 
active in that regard, while we in the United States have our own Edge’ 
Law. This law authorizes the formation of Foreign Trade Banks, 
which may buy acceptances and issue bonds against them. 


1 Monthly Letter on Economic Conditions, Government Finance, United States Securities, 
issued by National City Bank of New York, December, 1921, pp. 10-11. 


552 DOMESTIC AND FOREIGN EXCHANGE 


The above mentioned proposals are only a few of the more important 
suggestions that have been advanced as a means of stabilizing or 
rectifying the depreciated exchanges of the world. All undoubtedly 
have their good points; although for many of the schemes not much 
can be said in their favor. There may yet appear some plan that 
will prove to be adequate to meet the requirements of this extraor- 
dinary situation and which may be adopted by an international 
agreement among the more important nations, but it is doubtful, very 
doubtful, if that will occur. One nation alone can do little of a re- 
medial nature except to put its own financial house in order, and the 
possibility of an international agreement on any sort of scheme is so 
improbable that one is almost forced to conclude that the exchanges 
in the future will be allowed to work out their own salvation, alone 
and unaided by any of the above or similar proposals. There are al- 
ways present In the exchange field certain well-known correctives, 
discussed in earlier chapters, which, if allowed to function unhindered, 
will sooner or later bring conditions and relationships back to normal. 
It is time that war restrictions should be removed on exchange dealings 
of all sorts and that an absolutely free gold market be established by 
every nation. These two reforms would aid greatly in hastening the 
process of recovery. An adherence to contrary policies will merely 
retard the return of normal exchange relations. As an aid in bringing 
about the desired goal, to quote the official joint statement of the 
economists of the League of Nations,! “ It is essential that the infla- 
tion of credit and currency should be stopped everywhere at the ear- 
liest possible moment. To this end, Government spending must be 
cut down, the conduct of Government enterprise at less than cost and 
the payment of subsidies on particular commodities and services must 
‘as far as possible be abolished, and military and naval expenditure 
stringently restricted. The equilibrium of State budgets must be 
restored, loans not being employed to meet ordinary current require- 
ments. Artificially low bank rates out of conformity with the reai 
scarcity of capital, and made possible only by the creation of new 
currency, must be avoided. Floating debts should, as soon as practical, 
be funded. . . . The serious depression of certain exchanges beneath 
their real parities would be ameliorated by (a) the funding of floating 
debts held abroad in the form of notes; and (b) the restoration as soon 
and as far as practicable of normal trade intercourse between the 
different countries.” 

1G. Bruins, G. Cassell,.C. Gide, M. Pantaleoni, and A. C. Pigou. 















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APPENDIX I 


FORM OF AGREEMENT BETWEEN AN AMSTERDAM BANK 
AND ITS CORRESPONDENTS IN THE UNITED STATES 


GENERAL CONDITIONS FOR “CHEQUE” ACCOUNT 


WE CREDIT: 
Payments received 


Remittances on ourselves or other 
Banks at Amsterdam and Rot- 
terdam drawn in Dutch currency 

Ditto with documents 

Collections on Amsterdam and 
Rotterdam 

Collections on interior points 


Remittances in foreign currency 


Transfers on our books 


Discounts as per special arrange- 
ment at our best rate of the day 


WE DEBIT: 

Drafts on ourselves 

Drafts on our Provincial Branches 
to the debit of your account 
with us 

Drafts on our Provincial Corre- 
spondents to the debit of your 
account with us 

Payments to Banks and to Com- 
mercial Firms at Amsterdam 
and Rotterdam 

Payments to Banks and Com- 
mercial Firms in the Provinces 
Telegraphic transfers to Banks 
and Commercial Firms at Rot- 
terdam 

Telegraphic transfers to Banks 
and Commercial Firms in the 
Provinces 


Value 


Date of payment if received 
before noon 
Ditto 


Ditto 

Next business-day after 
payment 

Ditto 


Ditto 


Day of transfer, as indicated 
by our committents 


Date of receipt of advice 


Ditto 


Ditto 


Date of actual payment 


Ditto 


Date of actual payment 


Ditto 


Charges 


Free of Commission 


Free of Commission 


4 0/00; min. 50 cents 
Free of Commission 


Perte de Place, as per 
Collection Tariff 

Extra comm. % 0/00; 
min. to cts., otherwise 
same terms as bills in 
Dutch currency 

Free of Commission 


Free of Commission 
Free of Commission 


Uniform charge of 30 
cents, as per our Tariff 
for Direct Drawings 

Free of Commission 


¥% o/oo; min. 50 cents 
Per... 

Free of Commission 
subject to telegram- 
charges 
¥% o/oo; min. 50 cents 
plus telegram-charges 





559 


556 


Payments to private persons 

Telegraphic payments to private 
persons 

Payments in virtue of clean Com- 
mercial Letters of Credit 

Payments in Amsterdam and Rot- 
terdam, against taking up of 
documents 

Payments in the Provinces against 
taking up of documents 

Confirmation of clean or docu- 
mentary credits to the bene- 
ficiaries 


Payments in virtue of Travelers’ 
Letters of Credit 


Acceptances in virtue of Com- 
mercial Letters of Credit 


Transfers on our books 


APPENDIX I 


Value 


Ditto 
Ditto 


Ditto 


Ditto 


Ditto 


Ditto 


Ditto 


Day of maturity of the draft 


Charges 


¥% o/oo; min. 50 cents 


Y% ofoo; min. 50 cents 
plus telegram-charges 
¥% o/oo; min. 50 cents 


¥% 0/00; min. 50 cents 


I o/oo; min. fl. 1 


1/8% per 3 months or 
part, plus confirmation 
comm. of our corre- 
spondent, if any 

1/8% deducted from 
payment to benefici- 
ary with a min. of 50 
cts. and 1/4% if paid in 
the provinces. ‘This 
comm. is not deducted 
but charged to your 
accountif soinstructed 
30 d/s drafts 1/8% 


60 “cc “6 1/6% 

fe) ‘ec “ I 
se «c “cc ee 
37/0 


Confirmed Credits: 
1/8% additional 


Day of transfer, as indicated | Free of Commission 


by our committents 


AMSTERDAM, September 8th, 1920, 


APPENDIX II 


VALUES OF FOREIGN COINS 


Estimated by the Director of the United States Mint and used as 
the basis for estimating the value of foreign merchandise exported to 
the United States during the quarter beginning October 1, 1921.1 





Value in 
fae) eral i . Terms of 
ountry ie acard onetary Unit HE we i Remarks 
Money 

Argentine Republic.....| Gold.....] Peso...........-- $0.9648 | Currency: Paper, normally 
convertible at 44 per cent 
of face value; now incon- 
vertible. 

Austria~Hungary.......|... dosones Kronesit nese .2026 

gigi «5% 6 a. <bos x00 Gold and STANIC Melee =o Paes < .1930 | Member Latin Union; gold 

aly silver iy is actual standard. 

[spol hya bl. \ ey 2h eee Golds oes ae bolivianos. eee 3893 1244 bolivianos equal 1 

; Pea pound sterling. 

ISP R Zeta lat etter ss ie< os oF PON aad Milteis canes ae .5462 Currency: Government pa- 
per normally eaearrs 
at 16 pence ( =$0.3244 

er milreis. 

aaa. aan is AUSihse G0. o's os Pound sterling..... 4.8665 - 

tralasia an rica. 
GRERGG i Aon re GO cetete 5 Dollakte sew rran estes 1.0000 
Central American States: 
Costa Rica........-. aroma tr Colonvewe tease .4653 
British Honduras.....|...do..... Dollar deus egy anes 1.0000 
Wicaragus.. so. ..2s6el.. owas (Cordobain weeks: 1.0000 
Spies Urabe Currency, in- 
WA LCINGIG tare o's «510514 . convertible paper. 
er ondnceae carey tte } Silvers. cis Lessee ites - .4538 Honduras: Currency, bank 
notes. 

hes SPT whee ea Gold..... ge at eo . 5000 

Gifs aiece ara re valerate catsratenl 2410 GO nana SOBs ie cinerea one . 3650 Currency:  Inconvertible 
paper. 
TNO ore eis . 7439 

pens re: ee The tael is a unit of weight; 
. . not acoin. The customs 

Chin Kiang .7268 yar : 
Fuchau.--+| 9682 || Bus the Hellvan tae 
Tees 7570 are based on their rela- 
inkaw 6961 sees the Ralue of the 

Tael.. : bi : aikwan tael. 
: eet ind seo The Yuan silver dollar of 

See Ss oc cega ine ws e Silver. ... Niuchwang 6077 100 cents is the monetary 

Ningpo "71453 unit of the Chinese Re- 
Peking ge mead be ae ees 
. F r@) e KHalkwan 
ore ee 
akau....- . 7486 
Tientsin... .7209 
tae aterely .4875 
ongkong.. .4893 
Dollar) British... .| 4893 
Mexican... .4929 Mexican silver pesos issued 


under Mexican decree of 
Nov. 13, 1918, are of sil- 
ver content approximate- 
ly 41 per cent less than 
the dollar here quoted. 





11921 Annual Report, Director of the United States Mint, pp. 139-140. 
557 


Eos APPENDIX II 








Value in 
Terms of 
Country Legal Monetary Unit United Remarks 
Standard States 
Money 
Colombia wanes sent Goldfy kas |M GSO Bereccve, ce cle rier: .9733 Currency: Government pa- 
per and gold. 
Cubay ere centre, tea | ate Bharat aad GOL Neer wees 1.0000 
Denmarkissersee cose ae tec dozehs. Se He aye. s. bin 5 .2680 
Eciandone cee can tae aes GOR ae Sucte. eae, sues -4867 
Egypttoha. Sank alert lees Oana ENGae (100 piasters)| 4.9431 The actual standard is the 
British pound sterling, 
which is legal tender for 
97% piasters. 
Finland Aone spore cree | ae (slojun cal WMarkksa ge oat .1930 
PRADGE Sy 5 ot epee one Gold'and* i> Franeve to ves ae .1930 | Member Latin Union; gold 
silver. is actual standard. 
Germanys ce ee Golditier pelvlark seene tertneiiat .2382 
Great Britain eet ee cee Om Pound sterling..... 4.8665 
CSTOECE Ss cra eee ee Gold and | Drachma......... 1930 Do. 
silver 
Eaitiope oe. om ce Goldyecle Gourdenes sey cea .2500 Currency: Inconvertible 
paper. 
Endias(British)aeescemst ee Ose et Rupees ster acevser -4866 (10 rupees equal 1 pound 
sterling.) 
Indo-Chinartte ter eee Siulveraues |) LuaASterse cere sali -4901 
Et aly Oe ret vis moe as ete Crohns. sf) iTaen ieekes saa 0.1930 | Member Latin Union; gold 
is actual standard. 
Japa ora cone eee Ome tay Ven tee aero .4985 
Liberia metre el ee (Oe ss Dollar Vanier eee 1.0000 Currency: Depreciated sil- 
ver token coins. Cus- 
toms duties are collected 
in gold 
Mexico ar ee ska ae leo COs: Pesouesae. ene .4985 
Netherlands. sees one leer Co seect. Guilder (Florin). . -4020 
Newfoundland.........]... Gow Dollarye2eee ee 1.0000 
Norway oe cee eal falors hea Kirones ae . 2680 
Panaiia tes ene ee eee Gonna Balboas oe eae 1.0000 
PAaraguayere ie cert doeane Peso (Argentine)... .9648 Currency: Depreciated Par- 
aguayan paper currency. 
Persia Serene aan cect Silvereeiam |p eicTatns ssa ele clets, sive . 0836 Currency: Silver circulat- 
ing above its metallic 
value. Gold coin is a 
commodity only, nor- 
mally worth double the 
silver. 
Pert rane meee Goldie oe Webi es cree cs sla ets 4.8665 
Philippine Islands......]... relaen A PESO Be et aa ictente es .5000 ; 
Portugal sae eases dove. SCIdO occ ticle nore 1.0805 Currency: Inconvertible 
paper. 
Roumania ser aes eee en a dose USD eet order Oe .1930 
RUSssiav see eo eee eel one ral ae oe Riblev. sh ae sine «=i .5146 
Santo, Domingos. s.esn tere dokiene IDE ea AA eee ar 1.0000 
Serbla sccm ccmoeeen eae aot. OINAT Se ets ae eo . 1930 
SIAM. sere wae ae recto eee coloyeees fan laters ae Perea eee .3709 ois. 
Spann ete eae Gold and IPESEb aN ater, stele «oss 75 .1930 | Valuation is for gold peseta; 
silver. currency is notes of the 
bank of Spain. 
Straits Settlements Golds ae. | oDollantrre ye cre .5678 
Sweden owe ees Lae AO terrae LGD) 2 es Mee .2680 : ’ 
Switzerlandsees sence aee dotenes. ba Tey ee oa 5 ewe .1930 Member Latin Union; gold 
is actual standard. 
Pure yicge eect eters ote etl aitee donee Binster reas ie eis ace ts .0440 (100 piasters equal to the 
Turkish £.) 
Uruguay ree ce steer lsat dO: Seen Beso see Gece ee 1.0342 
Venezitela ts Awceteiceccclone dO ase iBOlivataee ace ce .1930 





APPENDIX III 


METHODS OF CONVERSION 


Although the average foreign exchange department is equipped 
with printed tables which facilitate the figuring of exchange rates, 
nevertheless it is well for the student to become acquainted with the 
more important phases of conversion practices. The following pages 
are concerned only with calculations in terms of English, French and 
German monies. Since we have lately begun the practice of quoting 
all exchanges by the direct method we no longer have recourse to the 
old methods of converting French and German money into that of our 
own country and vice versa, but it is well for the student to know how 
conversion of these two kinds of money was previously made so that 
he may understand earlier discussions of the subject. 


ENGLISH MONEY 


4 farthings = 1 penny 
12pence = 1 shilling 
20 shillings = 1 pound or sovereign 
21 shillings = 1 guinea 


Therefore 


Tes" 205.0-724A0d.e= O00. far. 
Ta = 4G far. 


face” @ Afar; 
A. Addition 
ta S. d. far. 
15 8 3 fe) 
38 6 2 3 
20 3 9 6 


1 oy 18s. Ad. 1 far. 


gfar. = 2penceandi far. Put 1 far. under the last column and carry the 2d. 
to the next column. The addition of the pence column, including the two 
that we have carried forward, gives 16d. which equals 1s. and 4d.. Carry 
the 1s. to the next column and add, which gives 18s. With nothing to carry 


559 


560 APPENDIX III 


to the £ column, we add and obtain £73. The correct answer is £73, 18s 
3d. 1 far. 
B. Subtraction 


£ S. d. far. 
14 3 6 2 
9 8 6 3 
£4 TAS.t5 “Lid. Baer. 


Starting at the right hand column again, we note that 3 cannot be subtracted 
from 2, so we take 1d. from the 6d. in the next column, leaving 5d. One 
pence = 4 far. so we add 4 far. to the 2 far., which gives us 6 far. Taking 
3 from 6 leaves 3 far. 6d. cannot be taken from 5d., so we take 1s. from the 
3s., leaving 2s. 1s. = 12d., so we add rad. to 5d. which gives 17d., and then 
take 6d. from it, leaving 11d. 8s. cannot be taken from 2s., so we take £1 
from the £14, leaving £13. £1 = 20s. Adding 20s. to 2s. and subtracting 
8s. leaves 148s. £0 from £13 leaves £4. The result is therefore £4 14s. 11d. 
3 far. 
C. Multiplication 
£386) css) Sd? paar 
ES 1d, ee Nee a 
SR405. ASS, © o7de pion tal 
Reducing the above product to its proper form, we note that 27 far. = 6d. 
3 far. We add 6d. to the next column and obtain 33d. which equals 2s. od. 
Adding 2s. to the next column gives us 47s., or £2 7s. Adding the £2 to 
£3465 gives £3467. Our correct product would therefore be £3467 7s. od. 
3 far. . 
D. Division 
£436 8s. 7d. 3 far. divided by 7 
7/436 
£62 and £2 remaining 
£2 = 40s. Add 4os. to 8s. and divide by 7 
7la8_ 
6s. and 6s. remaining 
72d. Add 72d. to 7d. and divide by 7 
7179 
11d. and 2d. remaining 
2d. = 8 far. Add 8 far. to 3 far. and divide by 7 
7|11 
1 4/7 far. 
The correct quotient is therefore £62 6s 11d. 1 4/7 far. 





6s. 





APPENDIX III 561 


E. Reducing English money to decimals of pounds sterling for ease in 
figuring 


Reduce £3 gs. 5d. to decimals 


A shilling is 1/20 of a £ or 5/100; therefore multiply shillings by 5/100 
or .o5. A pence is 1/240 of a £ or .004 1/6; therefore multiply pence by 
.004 1/6. To save trouble over the 1/6, multiply only by .o04 and add 1 if 
the product is between 13 and 35, and add 2 if the product is over 35. Thus 
£3 gs. 5d. reduced to decimals would equal: 


pee RATE 

98. = .45 

5d. = 021 
nc er Ga 


F, Conversion of United States money into English money 


Convert $10,000 @ 4.86 per £ 


Divide the American money by the rate per £, which gives the result in 
pounds and decimals of pounds. To reduce the decimals of pounds to 
shillings and decimals of shillings, multiply by 20 (the number of shillings 
per £). To reduce the decimals of shillings to pence, multiply by 12 (the 
number of pence per shilling). 








10,000 /4.86 
972 2057 .613 
~ 2800 20 
2430 12.260 
3700 
3402 .260 
“2980 12 
2916 520 
~ 640 260 
486 3.120 
1540 
1458 
82 


Answer = £2057 128. 3d. 


562 APPENDIX III 


G. Conversion of English money into United States money. 


Convert £2057 12s. 3d. at the rate of 4.86 per £. 


Reduce to pounds and decimals of pounds for ease of figuring, which 
gives £2057.613 and multiply by 4.86. 


2057.613 
4.86 


12345678 
16460904 
8230452 


$9,9099.99918 or $10,000 
FRENCH, BELGIAN, AND Swiss MONEY 


The franc of these three nations is divided into 100 centimes. Until De- 
cember, 1920, we quoted the franc by the indirect method, i.e., how many 
francs can be purchased for a dollar. We also used the supplemental per- 
centage fraction, as described in Chapter X. 


OLD METHOD 
A. Conversion of French money into United States money 


1. How many francs can be purchased with $1,000 at the rate of 5.1614 
Multiply the amount in dollars by the rate. 


$1,000 
5.1625 





Answer = 5162.5000 francs 


2. How many francs can be purchased with $1,000 at the rate of 
5.1644 — 1/16? 


Multiply the amount in dollars by the major quotation (5.1625), which 
gives 5162.5 francs. Then take 1/16 of 1 per cent of $1,000, which gives 
$.625 and convert that sum into francs at the rate of 5.1625, which gives 
3.226 francs. Add 5162.5 and 3.226, and the answer is 5165.726 francs. 
In converting dollars into francs, the minus sign before the percentage 
fraction makes the franc cost less, therefore we get more francs per dollar, 
and consequently reverse the sign and add 3.226 francs to 5162.5 francs to 
obtain the correct result. If the percentage fraction had been ++ 1/16, 
the francs would have cost more, i.e., we would have received fewer francs 
per dollar, and as a consequence we would have had to subtract 3.226 
francs instead of adding them. Thus in converting dollars into francs where 


APPENDIX III 563 


the percentage fraction is applied to the dollars, we reverse the sign before 
the percentage fraction. 


B. Conversion of French money into United States money 


1. How much will 5,000 francs cost at the rate of 5.1614? 


5000 + 5.1625 = $968.52 

Divide the amount of francs by the rate. 

2. How much will 5,000 francs cost at the rate of 5.1625 — 1/16? 

Divide 5,000 by 5.1625 which gives $968.52. Take 1/16 of 1 per cent 
of $968.52, or $.61 and subtract it from $968.52, which gives us the answer 
of $967.91. In converting francs into dollars, the minus sign before the 
percentage fraction makes the franc cost less, which means that we can 
get more francs per dollar, or in other words that we do not have to pay 
as much for them as we would at the major rate. If the fractional quota- 
tion had been + 1/16, francs would have cost more; we would have had 
to pay a larger number of dollars for 5,000 francs, and therefore would 
have added $.61 instead of subtracting it, making 5,000 francs at 5.1625 + 
1/16 cost us $969.13. Thus in converting francs into dollars when the 
percentage fraction is applied to the amount of dollars obtained by using 
the major quotation we follow the sign that appears before the percentage 
fraction. 

The above were the methods customarily used in such conversions, but 
the same results can be obtained if the percentage fraction is applied to 
the major franc quotation itself, provided the sign is reversed. 

1. Convert $1,000 into francs at 5.1625—1/16. 


1/16 of 1% of 5.1625 = .003266 
5.1625 + .003226 = 5.165726 
$1,000 X 5.165726 = 5165.726 francs 


The reason why the sign is reversed and the sum of .003226 francs added to 
the major quotation is because a higher quotation for the franc means 
that francs cost less or that more of them can be obtained for a dollar. 
If the percentage fraction had been + 1/16, the sum of .003226 would have 
been subtracted from the major rate of 5.1625, giving 5.159274, which when 
multiplied by $1,000 would have given 5159.274 francs. 

2. Convert 5,000 francs at 5.1625—1/16. 

1/16 of 1% of 5.1625 = .003226. Again reverse the sign and add .003226 
to 5.1625, giving us the rate of 5.165726. Divide 5,000 francs by 5.1657 
and the result of $967.91 is obtained. 


564 APPENDIX III 


NEW METHOD OF QUOTING 


The new method of quoting franc exchange presents no difficulties. The 
supplemental percentage fractions are no longer used and rates are quoted 
by the direct method. To convert 5,000 francs into American money at 
the rate of 20 cents per franc, we merely multiply 5,000 by 20 cents, which 
gives us the result of $1,000. If we want to know how many francs can 
be purchased for $1,000 when francs are quoted at 20 cents per franc, we 
divide $1,000 by $.20 and obtain the result of 5,000 francs. 


GERMAN MONEY 


' The basic unit of the German monetary system is the mark. The mark 
is divided into too pfennigs. Before December, 1920, we followed the 
policy of quoting mark exchange on the basis of what four marks cost in 
our money. Supplemental percentage fractions were used as in the case 
of franc exchange to shade the rates a little more closely. 


OLD METHOD OF QUOTING 
A. Conversion of German money into United States money 


1. How much will 10,000 marks cost at the rate of $.9525 per 4 marks? 

First find the cost per mark by dividing .9525 by 4. Result = $.238125 
per mark. Then multiply 10,000 marks by $.238125, which gives us the 
answer of $2381.25. The same result can be obtained by multiplying 
10,000 marks by $.9525 and then dividing the product by 4. 

2. How much will 10,000 marks cost at the rate of $.9525 + 1/32 per 
four marks? 

First find the rate per mark on the basis of the major quotation. $.9525 
~- 4 = $.238125. 10,000 marks at .238125 = $2381.25. We then take 
1/32 of x per cent of $2381.25, or $.74, and add it to $2381.25, which gives 
us our answer of $2381.99. If the supplemental fraction had been — 1/32 
we would have subtracted the $.74 instead of adding it. In converting 
marks into dollars we follow the sign appearing before the supplemental 
fraction. 


B. Conversion of United States money into German money 


1. How many marks will $10,000 buy at the rate of $.9525 per 4 marks? 

Divide $.9525 by 4 to get the rate per mark ($.238125). Divide $10,000 
by $.238125 to secure the number of marks that can be purchased with 
$10,000. Answer, 41,994.75 marks. 


APPENDIX III | 565 


2. How many marks will $10,000 buy at the rate of $.9525 + 1/32 per 
four marks? 

Again find the rate per mark on the basis of the major quotation. $.9525 
+ 4 = $.238125 per mark. Divide $10,000 by $.238125 and the quotient 
is 41,994.75 marks. 1/32 of 1 per cent of $10,000 is $3.125, which, when 
converted at $.238125 per mark gives 13.12 marks. Reversing the sign 
andadding 13.12 marks to 41,994.75 marks, we have as our answer 42,007.87 
marks. Had the supplemental fraction been + 1/32 we would have sub- 
tracted 13.12 marks instead of adding it. The reason for reversing the 
sign when converting dollars into marks is because a minus sign appearing 
before the supplemental quotation makes the mark cheaper and _ there- 
fore enables us to procure more of them for our dollars. If the sign is plus, 
the marks cost more, we get less of them, and we therefore have to subtract 
instead of add. 

While the above method of always applying the supplemental fraction 
to the dollars in the problem was generally followed, the same results can 
be obtained by applying the supplemental fraction to the marks instead of 
to the dollars. For example, in converting 10,000 marks into dollars at 
the rate of $.9525 + 1/32, if 1/32 of 1 per cent of 10,000 marks is taken 
(3.12 marks) and converted at the ascertained rate per mark ($.238125), 
the result will be $.74295. 10,000 marks at .238125 would equal $2381.25. 
Adding $.74 to $2381.25, we obtain the same result as we did in the previous 
example. Again, converting $10,000 into marks at the rate of $.9525-1/32, 
we first convert $10,000 at $.9525 per four marks, which gives us 41,994.75 
marks. If we take 1/32 of 1 per cent of 41,994.75, we obtain 13.1233 marks, 
which when added to 41,994.75 gives us the same result as in the paragraph 
above. 


NEW METHOD OF QUOTING 


As in the case of franc exchange, the new method of quoting mark ex- 
change has greatly simplified matters. We now quote on the basis of how 
many cents the mark is worth. We are no longer bothered with supple- 
mental fractions. To find out how much $1,000 will buy with marks at 
25 cents per marks, we simply divide $1,000 by $.25 and get the answer of 
4,000 marks. To ascertain how much 1,000 marks will cost us at 25 cents 
per mark, we multiply 1000 by $.25 and find that the cost is $250. 





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INDEX 


Acceptance, defined, 60, 64, 84-85; kinds 
of, 85-87, 138-130, 143-146; present- 
ment for, 89 

Acceptance, banker’s, defined, 70-71; ad- 
vantages of, 73-74; in domestic trade, 
72-78; in foreign trade, 236 ff; formerly 
forbidden in the United States, 77-78 

Acceptance, trade, defined, 64; in domestic 
trade, 62-70; in foreign trade, 232, 234 

Acceptance commissions, 16, 250-251 

Acceptance houses, London, 111; New York, 
100 

Acceptor, liability of, 88 

Actual rates, 312-313 

Advances of interest or credit to facilitate 
gold imports, 396-397, 407 

Advice, defined, 8 

Aldrich-Vreeland bank notes, 530 

Allonge, 81 

Anglo-French Loan of tors, 536, 545 

Arbitrage, defined, 513; four point, 516-517; 
parity sheets, 510; tables, 520-521; 
three point, 515-516; two point, 514-515; 
stabilizing effect on rates, 521 

Arbitration. See Arbitrage 

Argentina, 469-471 

Arrival or forward discount rate, 314-315 

Assignor, defined, 83 

Australian exchange, 
quotations, 304-305 

Authority to draw, 295-208 

Authority to purchase, 293-205 


270-275; London 


Bailee receipt, 247-248 

Bank credit used by importer, 234-235 

Bank of England, buying and selling price 
for gold, 376, 381, 382; control of gold 
movements, 402-407; discount rate de- 
fined, 115; making rate effective, 404; 
changes in rate during the war, 406; 
suspension of Bank Act in 1914, 528 

Bank of Belgium and gold flow, 400 

Bank of France and control of gold exports, 
407-408; gold premium policy, 408 

Bank of Nations proposed, 547-548 

Bank post money order. See Post money 
order 

Bank rate of discount, England, 402-407; 
Federal Reserve banks, 75; France, 406; 
Reichsbank, 406 


Banker’s acceptance. See Acceptance, 
banker’s 

Banker’s demand draft, domestic, 44-409; 
foreign, 182-195 

Banker’s long bills, 200-218; ordinary, 200; 
currency or dollar, 202-204; finance, 
206-212; sterling, etc., 204-206 

Bearer bills of exchange, 79 

Bibliography, 2-3 n 

Bill brokers, London, 107-111; New York, 
99-100 

Bill of exchange, defined, 22-23; classified, 
79, 137-140; clean, 14, 61, 139; docu- 
mentary, 14, 61, 139-140, 143 

Bill of lading, defined, 65, 140; clean, 161; 
order, 65; straight, 65; steamship, 159 

Branch banks, foreign, 113 

Brazil, 471-473 

Cable exchange, 137, 196-200; spread, 
351-352, 358-364 

Canadian exchange, 132, 
543, 544 

Cancellation of international debts, 549 

Cassell, G., and purchasing power parity 
theory, 482 

Chain rule, 449 

Checks, defined, 38; crossed, 87; in do- 
mestic trade, 38-44; in foreign trade, 
171-172; par collection of, 38-44 

Chile, 473-474 

China, monetary system, 
change, 443-451 

Circular letter of credit. 
letter of credit 

Clean bill of lading, defined, 161 

Clean bills, defined, 14, 61 

Clearing house loan certificates, 530, 532 

Collection of domestic bills, 38-44; foreign 
bills, 278-280 

Colonial clause, 270-273 

Commercial bills, acceptance of, 143-144; 
documentary, 14, 61-62, 139; payment, 
144-146; rebatable long bills, 144-146; 
with colonial clause, 270-273; with 
interest clause, 267-270. See Accept- 
ances, trade and banker’s 

Commercial letter of credit, domestic, 71-72 

Commercial letter of credit, foreign, ad- 
vantages of, 234-235; contents. of, 


393-304; 542, 


441-442; ex- 


See Traveler’s 


567 


568 


241-242; contract for, 238-241; dollar, 
236-251; legal aspects of, 287-293; 
progress in use of dollar letters of credit, 
254-255; confirmed, 281, 284-287; ir- 
revocable, 284-287; revocable, 284-287; 
revolving, 259-260; sterling, 251-252, 
256-259; unconfirmed, 282, 284-287; 
used in importing, 236-260; used in 
exporting, 260-268 

Commercial par of exchange, 
135 

Commercial parity, defined, 519 

Confirmed credits, 284-287 

Consular invoice, 167-169 

Conversion methods, 559-565 

Correspondent agreement, domestic, 17- 
18; foreign, 13-14, 555-556; instructions 
for drawing, 18-20 

Council Bills, 454-455 

Currency or dollar loans or long bills, 202- 
204, 339-340 

Corrective influence, of arbitraging, 521; 
of gold movements, 412-413; of rates 
of exchange on spread, 355, 358-359 


defined, 


Date bills, 61, 138 

Days of grace, 89, 137-138 

Dealers in exchange, England, 105-115; 
United States, 94-105 

Deferred Council Bills, 459 

Delegation, letter of, for transmitting 
funds, 195-196; for handling exports, 
298-2900 

Demand for exchange, sources of, 331-346 

Deposit allowance rate and cable spread, 
358, 363-364 

Depreciated exchange as protection against 
imports, 545 

Depreciated paper money exchanges, Ar- 
gentina, 469-471; Brazil, 471-473; Chile, 
473-474; Europe since 1914, 478-486 

Direct exchange, 302 

Discount, defined, 67; differentiated from 
interest, 67 

Discount houses, London, 107-111 

Discount rate, Bank of England, 115, 406; 
Federal Reserve banks, 75; Bank of 
France, 406; forward rate, 501-502; 
Reichsbank, 406; relation to exchange 
rates, 347; relation to investment in 
foreign bills, 493-494; relation to spread 
of long bills, 353-365; used to influence 
gold movements, 402-407 

Dishonor, 89-03 

Documentary bill of exchange, 14, 61-62, 
139-140 

Documentary payment bill, defined, 144; 
discountable in Germany, 145; not dis- 


INDEX 


countable in England, 145; rates, 350; 
speculation and investment in, 495-406 

Dollar commercial letter of credit, 236-251 

Dollar exchange, progress in use of, 254-255 

Dollar or currency loans or long bills, 
202-204, 339-340 

Dollar traveler’s letter of credit, domestic, 
52-58; foreign, 230 

Domestic exchange, defined, 4, 22; rates, 
47-48 

Domiciles or domiciled bills, 275-277 

Draft, defined, 58-59; classified, 60-62; 
bank domestic, 44-48; bank foreign, 
182-195; against stocks and bonds, 62, 
233; individual, 58-62 

Drawee, defined, 47, 80; liability of, 88 

Drawer, defined, 47, 80; liability of, 88 

Duplicate bills of exchange, reasons for, 157 


Earmarking gold, 104 n, 410-412 

Edge Law, 551 

Eligibility of bills for rediscount, 75-77 

Endorsement. See Indorsement 

England, exchange dealers, 105-115; legal 
tender, 373; methods of quoting ex- 
change rates, 309-311; mint and bank 
price of gold, 376, 381; monetary system, 
559. See Bank of England 

English exchange. See Sterling exchange 

Exchange as per indorsement, 275 

Exchange market most sensitive, 485 

Exchange rates. See Rates of exchange 

Exchange trader, 514; activities of, 5109, 
521, 523-525 

Export credits, 280-283 

Export letter of credit, 260-268. See 
Commercial letter of credit 

Exports as affecting supply of exchange, 
323-325 

Express company limited check, 175-177 

Express company money order, 26-27 


Federal Reserve Banks, forward discount 
rate, 315 n; Gold Settlement Fund, 32- 
33; par collection system, 39-44; re- 
discouunt rates, 75; rediscount operations, 
74-78; rediscount policy contrasted with 
that of European central banks, 68 n; 
telegraphic transfer system, 32-37 

Finance bills, 206-218; contrasted with 
dollar and sterling long bills, 206-207; 
effect on rates of exchange, 215, 327, 3393 
relation to speculation, 212-213 

Firm rate of exchange, 315, 487 

Fixed exchange, 302 

“Floaters,” 110 

Foreign coins, value of, 129, 557-558 

Foreign exchange, defined, 4 


INDEX 


Foreign loans, effect on rates of exchange, 
332-336; extent of, 333 

Forward discount rate, 314, 501-502 

Forward exchange operations, 213-214, 314 

Franc exchange, conversion into United 
States money, 562-564; basis of pro- 
gression, 317-319; method of quoting, 
317-319; mint par, 131-132 

French exchange. See Franc exchange 

Futures, 213-214, 314, 497-501 


German exchange. See Mark exchange 

Giro Conto system, 33 

Going long on exchange, 499 

Gold, distribution among nations, 418; 
theory of international distribution, 
419-424; world’s monetary supply, 371; 
world’s production, 371, 375, 376 

Gold exchange standard, defined, 452; 
India, 451-464; Philippine Islands, 464- 
564 

Gold exports, costs, 384-388; interest 
loss, 386; obtaining gold for export, 
England, 381-382; obtaining gold for 
export, United States, 374, 389; relation 
to cable rate, 388-389; restrictions on, 
England, 377-379; restrictions on, United 
States, 377; relation to supply of exchange, 
330; statistics of, United States, 414 

Gold imports, 389-392; costs, 390-391; 
encouraged by interest and credit ad- 
vances, 3096-397; interest loss, 390; 
Morgan-Belmont syndicate, 401; re- 
lation to demand for exchange, 341-342; 
relation to cable rate, 389-390; relation 
to sight rate, 389-390; restrictions on 
during the war, 424-425; statistics of, 
United States, 414 

Gold market, London, 373-376; New York, 
373 

Gold movements, absence of control over 
in the United States, 372, 400; classified, 
383; corrective influence of, 412-413; 
domestic minimized by Federal Reserve 
banks, 372; effect on commodity prices, 
419-424; encouraged by interest and 
credit advances, 396-397; minimized by 
international loans, 409; ‘relation to 
discount rate, 402-406; relation to money 
rates, 416-417; relation to premium on 
gold, 378-381, 3099; to premium on 
money, 397-399. See Gold exports, 
Gold imports, Gold shipments, Gold 
Settlement Fund, International Gold 
Settlement Fund, Gold points 

Gold points, defined, 383; affected by 
premium on money, 397-399; failure of 
gold points to function, 394-395, 413- 


569 


414; relation to mint par, 383-384; 
relation to sight rate, 371; variable, 387- 
388, 390-391; United States on England, 
392; United States on foreign nations, 
302-303 

Gold, price of, England, 376, 381; United 
States, 380 

Gold Settlement Fund, 32-33; domestic 
gold movements, 372; proposed Inter- 
national Gold Settlement Fund, 412 

Gold shipments, costs, 384-388, 390-3013 
diverted to India, 459-460; foreign inter- 
ference with during the war, 417-418; 
interest loss, 386, 390; made by bankers 
only, 383; made at a loss, 395-396; means 
of control by England, 402-407; by 
France, 407-408; by Germany, 408-409; 
by the United States, 401; relation to 
practical par of exchange, 387; triangular 
transactions, 393-304, 412; typical be- 
tween United States and England, 
384-392. See Gold exports, Gold im- 
ports, Gold movements, Gold points 

Gold standard, defined, 451 

Gresham’s law, 466 


Hedging, 213-214, 314, 497-501 

Holder in due course, 80 n 

House paper, 214 

Hypothecation certificate, 
letter, 153-155 


152; general 


Import letter of credit, 236-260; dollar, 
236-251; sterling, 253-259. See Com- 
mercial letter of credit 

Imports and demand for exchange, 331 

Improvement of exchanges, defined, 545- 
546; proposed methods, 546-552 

In case of need, 86 n, 147-148 

India, currency system, 454-455; 
exchange standard, 451-464 

Indirect exchange, 303 

Indorsee, defined, 80 

Indorser, defined, 80 

Indorsement, kinds of, 82-84 

Inflation and the exchanges, 474-486, 552 

Inland exchange, defined, 22 

Insurance, effect on exchange rates, 330, 
338-339; On marine shipments, 161- 
166; marine certificate, 140, 164-165; 
marine policy, 140, 163-165 

Intermediate Council Bills, 458 

Interest and discount differentiated, 67 

Interest clause, 268-270 

Interest free advances to induce gold im- 
ports, 396-397 

International Gold Settlement Fund, pro- 
posed, 412 


gold 


ae 


International standard of value, proposed, 
548 

Investment, defined, 490; contrasted with 
speculation, 490; in foreign bonds, 506- 
513; relation to foreign discount rate, 
493; relation to demand for exchange, 
331-336; relation to supply of exchange, 
328-330 

Invoice, defined, 65, 140, 166; consular, 
167-169 

Irrevocable credits, 284-287 


Joint account transactions, 202 
Joint stock banks, England, 113-114 


League of Nations’ proposal for improving 
the exchanges, 552 

Legal aspects of a commercial letter of 
credit, 287-293 

Legal tender, England, 373; United States, 
syle 

Letter of credit. See Commercial letter of 
credit, Traveler’s letter of credit 


Letter of delegation, for transmitting 
funds, 195-196; for handling exports, 
298-209 


Letter of guarantee, authority to pur- 
chase, 294; commercial letter of credit, 
238-230; traveler’s letter of credit, 225 

Letter of indication, 54 

Liability of parties to bill of exchange, 88 

Limited check, 175-177 

London, gold market, 376; silver market, 


427-428 
Long bills, banker’s, 200-218; dollar or 
currency, 202-204; finance, 206-212; 


sterling 204-206 

Long on exchange, going, 490 

Long rates of exchange, spread, 353-357, 
359-365 

Lord King’s law of currency, 479 


Mark exchange, basis of progression, 316; 
conversion methods, 564-565; method 
of quoting, 315-316; mint par, 132 

Mercantilism, 418-419, 424 

Methods of conversion, into United States 
money and vice versa, francs, 562-564; 
marks, 564-565; sterling, 561-562 

Methods of quoting foreign exchange 
classified, 302-305 

Mint par defined, 130-131; between im- 
portant countries, 131-133 

Mint price of gold, England, 376; United 
States, 382 

Monetary standards, gold, 451; gold ex- 
change, 452; silver, 440; paper, 465 

Monetary systems, Belgium, 562, China, 


INDEX 


441-442; England, 5509; France, 562; 
Germany, 564; India, 454 


Money orders, express, 26-27; postoffice 
domestic, 23-26; postoffice foreign, 
172-175 


Money rates and demand for exchange, 
340-341; and supply of exchange, 326-327 

Moratoria, 528-529, 532 

Morgan-Belmont syndicate, 401 

Movable exchange, 303 


National Gold Fund, 531, 534 

Negotiable Instruments Law, Uniform, 22 n 

Negotiability, defined, 81 

Negotiating a bill of exchange, 80; liability 
of parties, 88 

Neutral exchange, defined, 136; during and 
since the war, 539, 541-542 

New York exchange, defined, 44-45 

New Zealand rates of exchange, 304 


Open book account system of financing 
domestic trade, 62-63 

Open discount market, England, 107-114; 
United States, 77-78 

Order bill of lading, 65 

Order bills of exchange, 79 

Overdraft in financing domestic trade of 
England, 64 n; in gold shipments, 386 


Paper standard, defined, 465; and depreci- 
ated exchanges, 465-486; effect on prices, 
467,476-477; effect on commerce, 467-468 

Par check collection system, 39-44 

Par, mint. See Mint par 

Parities, commercial, 519-521 

Parity sheet, 519 

Parity tables, 520-521 

Payee, defined, 47, 80 

Payer, defined, 47, 80 

Pegging the exchanges, England, 536-539, 
548 

Philippine Islands and gold exchange 
standard, 464-465 

“Pig on pork”’ bills, 214 

Pittman Act, 432-433, 435-436 

Positions or position sheets, 521 

Post money order, 177-182 

Postal remittance. See Post money order 

Posted rates, 312-313, 322 

Postoffice money order, domestic, 23-26; 
foreign, 172-175 

“Practical par of exchange,” 387 

Premium and discount method of quoting 
exchange, 303-305 

Premium on gold, England, 378-381, 466, 
479; France, 408; and rates of exchange, 
478-479 


INDEX 


Prepayment, of acceptance bills, 144; of 
documentary payment bills, 144 

Presentment of negotiable instruments, 89 

Price levels, effect on of gold flow, 419-424; 
of depreciated paper money, 467-486 

Private banks, England, 113 

Profit and loss position, 521-522 

Profits of exchange dealers, 525 

Proposed remedies for the disarranged 
exchanges, 546-552 

Protest, 83, 90-93 

Purchasing power parity, 478-486 


Quantity theory of money, 420 

Quotation of rates, methods classified, 
302-305; in England, 304, 309-312; in 
the United States, 305-309, 315-310; 
franc, 317-319; mark, 315-317; sterling, 
315 


Rate of discount. See Discount rate. 

Rate of exchange, defined, 129; methods of 
quoting, 302-305; range of, 319-321; 
spread of, 352-365; improvement of, 
545-552; stabilization of, 545-552; tables, 
England, 304, 309-312; tables, United 
States, 305-309 

Rate sheet, 176, 180 

Rebatable commercial long bills, 144-145 

Recourse, without, 83, 207 

Rediscount, defined, 67; forward rate, 314, 
501-502; policy of Bank of England, 115; 
policy of Federal Reserve banks, 75-76 

Referee in case of need, 86 n, 147-148 

Reform of exchange practices, 488 

Reichsbank and control of gold exports, 
408-409 

Retirement rate of discount, 144 

Return bill or draft, 261 

Reverse Council Bills, 455 

Restrictions during the war on gold exports, 
England, 377-381, United States, 377; 
on gold imports by neutral countries, 
424-425 

Revolving letters of credit, 259-260 

Risks of exchange dealings, 487-488, 525- 
526 

Royal Exchange of London, 105-107 

Rupee exchange, 452-464 


Sales contract as part of the commercial 
letter of credit, 241-242 

Shanghai exchange, 442-451 

Short selling, 497 

Sight bills, defined, 60 

Sight rate as basis of other rates, 348-340; 
of gold shipment calculations, 371 

Silver exchanges, China, 440-451; effect 


572 
on commerce, 445-447; effect on invest- 
ment, 447 

Silver imports and exports, United States, 
440 

Silver market, London, 427-428; New York, 
435 


Silver production, 427 

Silver parity, Shanghai on London, 448- 
450; on New York, 450-451 

Silver, price, 429-437; causes affecting, 
420-432; future, 428; London, 429; 
New York, 430; relation to commodity 
prices, 437; relation to melting points of 
silver coins, 437-439; spot, 428 

Silver standard countries, 427 

South African rates of exchange, 304 

South American exchange, 469-474 

Special Bills, 458 

Specie points. See Gold points. 

Speculation, defined, 490; by use of sight 
drafts, 505; contrasted with investment, 
490; during and since the war, 502-513; 
going long on exchange, 499; going short 
on exchange, 497; in finance bills, 213; 
in foreign bonds, 506-513; in foreign 
currency, 505-506; in futures, 499-501; 
prohibition of, 549-550 

Spread of exchange rates, 351-365 

Stabilization of disarranged exchanges, 
proposed methods, 545-552 

Sterling exchange, basis of progression, 315; 
conversion methods, 559-562; methods 
of quoting, 315; mint par, 131; superior- 
ity of, 258; used as return drafts, 261, 
264, 266 

Sterling letters of credit. See Commercial 
letter of credit, Traveler’s letter of credit 

Sterling loan or long bills, 204-206 

Stock exchanges, closed by war, 527-528; 
opened, 533 

Straight bill of lading, 65 

Supply of exchange, sources of, 323-330 

Suspension of the Bank Act of England in 
1914, 528 

Swapping exchange, 212, 523 


Tael, 441-442 

Tariffs and the exchanges, 480 

Telegraphic transfer, domestic, telegraph 
companies, 27-29; banks, 290-32; Federal 
Reserve banks, 32-37. See Cables 

The Meulen plan, 550-551 

Theory of the exchanges, 123-125 

Time bills or drafts, 60 

Trade acceptances. See Acceptances 

Traders, exchange. See Exchange traders 

Transferee, defined, 80 

Transferrer, defined, 80 


572 INDEX 


Traveler’s check, domestic, 40-52; foreign, Uniform Negotiable Instruments Law, 22 n 
220-223 Unpegging exchange, 543 
Traveler’s letter of credit, domestic, 52758; Usance, defined, 140 
foreign 223-232 
Triangular exchange, 344-346, 393-304, 412 Vendee, defined, 80 
See Arbitrage Vendor, defined, 80 
Trust receipt, 244-250 
Without recourse, 83, 207 


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